Mason Hawkins Comments on JCP, DELL, CHK in Shareholder Meeting Presentation
As we discussed often and many of you know, Benjamin Graham spent most of his professional life defining intelligent investing. His two incomparable texts, Security Analysis and The Intelligent Investor, provided the tools for valuing investments, and the necessary psychological framework for successful capital commitments. Warren Buffett, by example and through his lucid writings, has added materially to those disciplines, and we've applied those disciplines fairly intensively for the last 40 years. Graham summarized his work postulating the imperative that every good investment must qualify quantitatively and qualitatively. Quantitatively, capital investments should be made only when prices are significantly discounted from conservative appraisals. Qualitatively, companies should be competitively advantaged and expected to grow. And management ought to be shareholder oriented, operationally competent, and sage capital allocators.
We've distilled these mandatory investment requirements, as you've heard, down to business, people, and price. Over the last four decades that we've practiced value investing, we've had a successful history assessing companies' competitive strengths, getting our appraisals, quote, "approximately right," and making investments at the requisite discounts from definable values. Where we and the best investors have been challenged is always getting it right on people, the CEOs to whom we entrust your and our investment dollars. Ron Johnson's recent short time at JCPenney (JCP) highlights how disastrous it can be when you really get it wrong. Inevitably, if you are a long-term investor, one of your companies will be faced with a leadership challenge. When the company's underlying assets are strong, the stocks' undervaluation is compelling and the primary needed, quote, "fix," relates to people, you can expect us to become active and to improve the governance and management of the business. Activism is not part of our normal process, nor is it our preferred responsibility. When we make an investment, we objectively believe we have management partners who run the business well, wisely allocate capital, and ultimately seek paths to value recognition. In the large majority of our investments, our partners prove capable.
Judging humans, however, is more difficult and less reliable than analyzing the quality of a business or appraising value. Nothing can measure people's future actions, no matter how good their previous work may have been or how strong and properly aligned their incentives are with shareholders' interest. Becoming active generally indicates we made a mistake assessing our partners on the front end. Staley's going to talk more about our history of active management engagement.
When you really get it right on corporate stewardship, the long-term returns for shareholders goes up exponentially. William T. Thorndike, Jr. has just written a masterpiece on corporate leadership entitled The Outsiders. In Will's anthology of eight unconventional CEOs, he chronicles their quote, "radically rational blueprint for success." We commend it to you as one of the best books on corporate management we've ever read.
Throughout the years, Southeastern's been fortunate to have owned seven of the eight companies these all-stars have led. The corporate leaders and their companies are: Tom Murphy at Capital Cities Broadcasting, Henry Singleton at Teledyne, Bill Anders at General Dynamics, John Malone at TCI et al., Katherine Graham at the Washington Post Company, Bill Stiritz at Ralston Purina, Dick Smith at General Cinema, and Warren Buffett at Berkshire Hathaway. Each was a first time CEO; ran decentralized organizations focused on free cash flow production while delegating operational duties to others; reserved capital allocation for themselves; paid no or low cash dividends; except for Buffett, bought back over 30 percent of their company's shares when they were undervalued; made at least one key acquisition that was greater than 25 percent of their company's market cap; minimized taxes; and, never gave Wall Street guidance.
Their mantra was to prudently optimize long-term value per share and it was their investment acumen that made their long-term owners wealthy. Each evaluated opportunities independently, was disciplined and demanded high returns on capital deployed. They were incredibly patient, often waited long periods for, quote, "fat pitches." When an opportunity showed up, they carefully analyzed it themselves, without consultants or advisors. And when they were certain they wouldn't lose, made huge investments that dramatically enhanced their companies' worth.
As I'm sure you've deducted, the iconoclastic and idiosyncratic attributes of The Outsiders are characteristics common in great investors. You and Southeastern are lucky to have seven young, nascent investment all-stars working for Longleaf that possess these important talents. They are Brandon, Josh, Ken, Lowry, Manish, Ross, and Scott, and they've been hugely responsible for the Funds' good recent returns. Would you guys please stand up so we can all thank you. (applause)
Thorndike compares The Outsiders' stock performance record to that to the oft acclaimed record of Jack Welch's GE and to the S&P 500. Incredibly, as you can see from Will's graph on page 198 of The Outsiders, the composite of The Outsiders' returns were multiples of Welch's and some 30 times the S&P 500 over their average tenure of 25 years. As these data show, great corporate partners, people, really matter. You can be assured that we've partnered with many terrific ones, ones that will be on future Outsiders' lists. Staley, Scott, and Ken are going to give some great examples. Staley. (applause)
When Partners Disappoint vs. Most Who Don't: Staley Cates
Mason explained why we've become active and how activism is more about fixing a mistake rather than our preferred way to manage a position. But activism is not our only recourse when we make a research error. Most of the time we simply exit the position. Because we have moved on, people easily forget that exiting is our normal path, and although an automatic sale rule when something goes wrong might be even easier, we have a responsibility to evaluate the investment case before deciding whether to sell or get active. Besides requiring the mandatory attributes of strong and undervalued assets, we will generally become active only if we also believe we have very good odds of successfully improving our clients' outcome. This approach to activism is neither new to Southeastern nor does it happen often. And by the way, this is the first time in 20 years of boring speeches I have used slides, I have seven slides, one for each hour of my talk.
In the last 20 years, we have owned 255 U.S. names and filed just 26 13Ds, and for those of you that don't know, a 13D is an SEC filing that changes our status to active. While activism outside the U.S. is not subject to a clear 13D-type designation and thus is harder to track, a subjective review shows a similar low level of activity in non-U.S. names.
The second slide shows that the 26 13D filings have been spread over a long history. It shows the holdings per year and shades those where we became active. Fighting for our clients has been worth the effort. In over three-fourths of the cases where we filed 13Ds, the stock price rose from the filing point through our holding period. So in total, these charts demonstrate that, number one, making management assessment mistakes that warrant activism has been infrequent; number two, becoming active is not a recent tactic, even though the media attention on Dell and Chesapeake make it seem like it; and number three, standing up for our clients via activism has been worthwhile.
Besides Dell (DELL) and Chesapeake (CHK), we have also worked productively in the last year with HRT and with Level 3 to improve governance and ultimately results, though the stocks do not yet reflect that progress. Fortunately at our 52 other holdings across portfolios, management appears to be working hard for the benefit of shareholders. No doubt that in the future, a small percentage of those 52 might change for the worse, but odds are very good that we will continue to check the people box for the vast majority of the 52.
So our more normal MO is picking great assets run by partners with whom we don't foresee any fighting, purchased at very cheap prices. It bears repeating that if the greater outside world agreed with us that these assets are of high quality, we would have to pay a much higher price. So we seek quality that diligent research can appreciate but that lazy or superficial research will not. In this regard, Dell's growing and high margin enterprise assets are obscured by the PC, and Chesapeake's incredible and well diversified gas reserves, oil reserves, and land positions are obscured by the governance dramas and the spot natural gas price.
Continue reading the transcript here.