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First Eagle's Kimball Brooker on Finding Value in Global Holding Companies
Posted by: Holly LaFon (IP Logged)
Date: June 5, 2012 11:21AM
The PM’s Perspective is a series of interviews with senior members of First Eagle’s investment teams. As a firm with a long tradition of independent thinking, we invite you to read market views and strategic insights that come straight from our investors.
Q: Why do you prefer to own a holding company’s stock rather than the basket of individual stocks in its portfolio?
In many cases, it wouldn’t be possible to precisely replicate a holding company’s investments by acquiring interests in publicly traded securities because many holding companies have investments in private companies, limited partnerships, real estate, or other assets which are not publicly traded. But with that said, there still may be reasons to own shares of a holding company rather than the basket of the individual stocks in its portfolio.
I suppose the first reason is the potential to acquire the assets within the holding company at a discount to their intrinsic value. For a variety of reasons holding companies can periodically trade at substantial discounts to the value of their underlying assets, even if those assets have readily ascertainable values. In the case of Groupe Bruxelles Lambert, or GBL, which is a Belgium-based holding company, substantially all of its holdings are large, high-quality publicly traded European companies. Its holdings range from Pernod Ricard, a wine and spirits business, to Total, an integrated oil company. An investor could basically recreate GBL’s underlying portfolio by buying shares of the companies it owns. But in GBL’s case, the holding company trades at a 30% discount1 to the sum of its parts based on current market values.
An additional reason for investing in holding companies is the alignment of interests many holding companies afford to minority investors. Many holding companies have a high degree of inside ownership which results in a direct economic alignment with outside shareholders. Very often the time horizon of the principals is more consistent with long-term investing. For example, Wendel S.A., a French holding company, has existed for 300 years and the Wendel family is still the largest owner. Like us, they're not all that focused on the next quarter. Instead, this firm is more willing to make decisions based on the longer-term interests of the businesses they have owned for generations.
Another reason may be the influence that holding companies exert on the companies they've invested in. Many holding companies play the role of professional long-term investor. In this capacity they're prepared to hold substantial ownership positions for long periods of time, sit on the board of directors, and seek to actively influence the strategy of a company. For example, Investor AB has owned a number of its core industrial positions since the early 1920s and takes a very active role in the governance of the businesses it owns. I think this kind of arrangement can really help to mitigate the problems that may arise as a result of the inherent conflict between the shareholders and management.
Finally, some holding companies may have competitive advantages either in sourcing or managing their investments. Some companies have very deep levels of experience in particular industries. For example, HAL Trust has had a long record of successful investments in marine logistics and infrastructure. Other holding companies may have informational advantages based on geography. Investor AB, for example, which was founded and is still controlled by Sweden's Wallenberg family, is intimately familiar with business activity and potential investment opportunities in Scandinavia. The depth of this local knowledge is not easily replicated. Sometimes reputation may play a role. Over and above its financial resources, Berkshire Hathaway's reputation as a careful buyer and thoughtful owner surely placed it in an advantaged position during the last few years when it came to sourcing investment opportunities.
So even though investors may have the option of investing directly in the underlying securities of a holding company, other factors ranging from enhanced governance to valuation to certain kinds of competitive advantages may make investing in holding companies attractive.
Q: We've heard you speak of a "double discount" with holding companies. What does this term mean?
The term "double discount" applies when two layers of valuation discounts exist. The first discount may arise when the holding company trades at a discount to the sum of the parts. In the case of Groupe Bruxelles Lambert, for example, whose assets are almost entirely shares of public companies, the holding company trades at approximately a 30% discount2 to the sum of those investments. A second layer of discount may arise based on our estimates of the intrinsic value, as opposed to the market value, of the companies within a holding company. A "double discount" arises when the holding company is trading at a discount to the market value of its assets and the market value of its assets are trading at a discount to our estimates of their intrinsic value.
Q: What accounts for the existence of a discount at the holding company level?
One of the tenets of value investing is that a company's share price may not reflect the value of the underlying business. There are obviously times when a stock price does reflect the intrinsic value of a business but there can be moments when the stock price is either higher or lower than the intrinsic value of a given business. The same is true of holding companies in the sense that some trade at premiums to the intrinsic value of the businesses they own and some trade at discounts.
Some holding companies have traded at persistent discounts to the readily ascertainable value of their underlying assets. Some have argued that a discount should exist for all holding companies because of the diversity of the assets, the complexity of the structure or other reasons. I think the question of whether a holding company should trade at a discount is more complicated and should be considered in the context of the specific holding company. There are situations where I think a discount is justified: if the quality of the underlying assets are poor or opaque; if the balance sheet is overleveraged; if the holding company expenses are too high; if there's a large embedded tax liability; or if management is destroying value in one way or another.
On the other hand, I think for a holding company with a long track record of prudent and successful capital allocation, with high quality assets, and limited tax leakage, a discount becomes harder to justify.
Q: Given all of this, why are holding companies generally under-appreciated by the market?
They tend to fall through the cracks for a variety of reasons. Sometimes the liquidity in the holding company stock is not high enough for some investors. Often, there's not a lot of sell-side research coverage and most holding companies don't make a huge effort on the investor relations front. Very often the corporate structure is very complicated and many investors don't have the inclination to take the time and effort to understand those structures and related tax implications in their country of domicile. Once you overcome these hurdles you still have to put in the time to value the component pieces. This can be complicated depending on the kinds of businesses they've invested in, whether they're private or public and so on.
Separately, some investors believe that because a holding company's discount can persist, they may not generate a positive return on such a position. If a holding company can increase its economic earnings, however, even if the market multiple remains the same the investor may realize meaningful gains.
This doesn't mean they're neglected by all investors. They aren't. But they tend to be owned by value investors like us.
Q: Do the large family ownership stakes in these companies also put off investors? That's possible. Typically investors have to grapple with whether they want to be a minority shareholder in a family-controlled holding company with very limited prospects of imposing changes to the board or management. So I'd say that in the case of family-controlled companies, one needs to exercise considerable care and diligence in assessing the character of the family. Not all holding companies are owned or managed by competent principals but many are. And many have long records of excellent capital allocation and fair treatment of their shareholders. I spoke earlier about the idea that many of these companies have very long time horizons and are less susceptible to short term thinking or Wall Street's "trends du jour." One thing that gets less attention is the notion that many family-controlled holding companies are focused on broader issues beyond the financial success of the company. They're also likely to be focused on their reputations, their role in the communities they operate in and their legacies. These can be powerful motivators to not do the wrong thing and this, too, can help serve to mitigate investment risk.
Q: Why are these names either not in the Index, or else a very small weight in it? First Eagle is known to be "benchmark-agnostic," but is this something you've thought about?
Most of the world's major indexes have adopted "free-float methodology" for calculating the weight of their underlying companies. Many holding companies have low free float because the large controlling stakes by company founders or founding families are excluded from "float." This low free float disqualifies them from being included in indexes.
Q: Do you prefer mono-asset holding companies like Heineken Holding to more diversified opportunities like Jardine Matheson?
We do not have a preference one way or another. Heineken Holding represents one end of the holding company spectrum in the sense that its only asset is a 50% ownership interest in Heineken NV, the global beverage company. In the case of a mono-asset holding company like Heineken Holding, the analysis would obviously require an understanding of Heineken, the competitive dynamics of the global beverage business, and so on.
At the other end of the spectrum would be Jardine Matheson, commonly known as Jardines, which is one of the most diversified holding companies in the world. It was founded as a trading company in China in 1832, and today it's a Fortune 500 company that's listed in Singapore. Jardines has roots in the founding of Hong Kong, where it still owns very important real estate assets which are really the core assets of the group. It owns about 50% Hongkong Land Holdings which owns about five million square feet of commercial office space in the heart of the business district of Hong Kong. It also has a controlling interest in Mandarin Oriental, which was originally a Hong Kong hotel before becoming an international hotel chain and management company. Over the centuries, Jardines has also invested in engineering and construction, transport services, insurance brokerage, retailing, restaurants, motor vehicles, financial services, heavy equipment, mining and agribusiness. It's about as diversified as a company can be. We hold Jardine Matheson because in our view, it's a leader in all of the businesses it's in. The structures of the industries its underlying businesses operate in are also attractive. For some, the competitive landscape is relatively benign; for others, the businesses are unique enough that they simply couldn't be recreated. Hongkong Land's holdings in the Central District in Hong Kong are not replicable today.
Q: Is it hard to value a company that's in so many different sectors of the economy?
Not necessarily. It may be very time consuming and require a team of analysts with differing industry expertise to arrive at a valuation. In the case of Jardines most of the larger holdings are themselves public companies which file their own financial reports. Holding companies that own private companies can be can be more difficult to value depending of the level of disclosure available. We have looked at a few holding companies which we've passed on because we couldn't get comfortable with the limited disclosure.
Q: What kinds of tax issues need to be taken into account when you're valuing a holding company?
Around the world, there are many different tax regimes for holding companies, and you do need to be aware of them. Some jurisdictions have specific tax rules for investment holding companies, but elsewhere the tax treatment of holding companies is just part of a broader capital gains and dividend tax regime. In some countries, the dividends that the holding company receives from its underlying companies may be deductible if paid out to the holding company's shareholders. In other countries, there may not be taxes on the dividends that a holding company receives from its underlying companies as long as the holding company's ownership interest exceeds a certain threshold. Furthermore, some countries don't have capital gains taxes.
Q: Are there particular risks to consider when investing in holding companies?
One area we pay particular attention to is the nature of its balance sheet leverage. You can have a scenario where there's financial leverage at the underlying asset level and at the holding company level as well. The debt at the holding company is effectively secured by the shares in these underlying companies and is reliant on the dividends from the underlying companies to service interest or principal payments. If a 'double discount' is a nice thing to find, 'double leverage' is a red flag. We're generally not comfortable with this kind of leverage because when business conditions deteriorate even modestly, highly leveraged companies can be vulnerable.
Another area to consider are the expenses incurred by the holding company itself. Generally holding companies will employ reasonably small investment teams to source and monitor their investments. There is a risk that the expenses at the holding company become excessive.
Q: How large an allocation do you make to holding companies?
We don’t have a top down approach to allocations either by industry, geography, or any other category. Instead the composition of the portfolio is driven by fundamental analysis and the positions are based on underwriting each individual security. Longterm investments may be substantial. Earlier I mentioned Groupe Bruxelles Lambert (GBL). Taken together with its overlapping holding company, Pargesa, they currently represent one of the largest holdings in both our Global Fund and Overseas Fund. This is because of our comfort with the quality of the assets, the quality of the management and the size of the valuation discounts.
Kimball Brooker, Jr. Kimball is a portfolio manager for the First Eagle Global, Overseas and U.S. Value Funds. He joined First Eagle's Global Value team in 2009 as a senior research analyst covering banks, commercial services, financial services and holding companies.
Kimball began his career in 1992 as a financial analyst at Lazard Frères & Co. From there, he joined J.P. Morgan as an associate in the Investment Banking Department's billion-dollar Corsair private equity funds. In 1998, Kimball returned to J.P. Morgan after finishing his M.B.A. He was named Chief Investment Officer of the Corsair Funds and managing director in 2005. In 2006, Corsair successfully completed a spin-off from J.P. Morgan with nearly $3 billion under management.
Kimball received his B.A. from Yale University and his MBA from Harvard University.
The performance data quoted herein represents past performance and does not guarantee future results. Market volatility can dramatically impact the fund's short-term performance. Current performance may be lower or higher than figures shown. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Past performance data through the most recent month end is available at firsteaglefunds.com or by calling 800.334.2143. The average annual returns for Class A Shares "with sales charge" of First Eagle Funds give effect to the deduction of the maximum sales charge of 5.00%.
There are risks associated with investing in funds that invest in securities of foreign countries, such as erratic market conditions, economic and political instability and fluctuations in currency exchange rates. Funds whose investments are concentrated in a specific industry or sector may be subject to a higher degree of risk than funds whose investments are diversified, and may not be suitable for all investors.
Investment in gold and gold related investments present certain risks, and returns on gold related investments have traditionally been more volatile than investments in broader equity or debt markets.
The principal risk of investing in value stocks is that the price of the security may not approach its anticipated value or may decline in value. The information is not intended to provide and should not be relied on for accounting or tax advice. Any tax information presented is not intended to constitute an analysis of all tax considerations. Many holding companies are considered Passive Foreign Investment Companies ("PFIC") for U.S. investors.
The holdings mentioned herein represent the following percentage of the total net assets of the First Eagle Funds as of March 31, 2012: First Eagle Global Fund: Groupe Bruxelles Lambert S.A. 0.61%, Pargesa Holding S.A. 0.77%, Pernod Ricard 0.00%, Total S.A. 0.55%, Wendel S.A. 0.40%, Investor AB 0.44%, HAL Trust 0.00%, Berkshire Hathaway 0.94%, Heineken Holding 0.00%, Heineken N.V. 0.00%, Jardine Matheson Holdings 0.17%, Hongkong Land Holdings 0.00%, Mandarin Oriental 0.00%; First Eagle Overseas Fund: Groupe Bruxelles Lambert S.A. 0.26%, Pargesa Holding S.A. 1.46%, Pernod Ricard 0.00%, Total S.A. 0.75%, Wendel S.A. 0.42%, Investor AB 0.69%, HAL Trust 0.58%, Berkshire Hathaway 0.00%, Heineken Holding 0.00%, Heineken N.V. 0.00%, Jardine Matheson Holdings 0.46%, Hongkong Land Holdings 0.00%, Mandarin Oriental 0.00%. The portfolio is actively managed and holdings can change at any time. Current and future portfolio holdings are subject to risk.
The commentary represents the opinion of Kimball Brooker as of May 2012 and is subject to change based on market and other conditions. The opinions expressed are not necessarily those of the firm. These materials are provided for informational purpose only. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. The information provided is not to be construed as a recommendation or an offer to buy or sell or the solicitation of an offer to buy or sell any fund or security.
The First Eagle Funds are offered by FEF Distributors, LLC, 1345 Avenue of the Americas, New York, New York 10105. First Eagle Investment Management, LLC became investment adviser to the Global Fund commencing January 1, 2000. Investors should consider the investment objectives, risks, charges, and expenses of a fund carefully before investing. The prospectus and summary prospectus contain this and other information about the fund, and may be obtained by contacting your financial adviser, visiting our website at firsteaglefunds.com or calling us at 800.334.2143. Please read the prospectus carefully before investing. Investments are not FDIC insured or bank guaranteed, and may lose value.
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