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Joe Ponzio
Joe Ponzio
Articles 

Notes from the Pabrai Funds 2008 Annual Meeting

October 01, 2008

On September 13th, I attended the 2008 Pabrai Funds annual meeting held here in Chicago. I met a few F Wall Street visitors and, unfortunately, missed meeting up with a few others. I must say that I am amazed at how many "Early Buffett" partnerships are out there.

For the explosive growth of these types of partnerships, I give 100% of the credit to Mohnish Pabrai for structuring his partnerships like the early Buffett ones and bringing them to the public eye. (If that's Greek to you, or if you're Greek and that's Chinese, stay tuned because I'll explain "Early Buffett Partnerships" in a subsequent post.) Before Pabrai, few people knew what an "Early Buffett" partnership was.

But I digress (and I'll get back to these partnerships later). For now, let's look at the Pabrai Funds 2008 annual meeting.

A Look at Performance

Pabrai's funds are all about long-term performance; so, looking at his one-year or year-to-date performance is downright silly. Sure, he'd love to show positive gains every year; still, even Charlie Munger himself couldn't pull off that feat, and Munger's not too shabby of an investor!

You didn't know? Like Buffett, Munger ran a partnership in the 1960s and 1970s. And like Buffett, he killed the Dow — except in 1973 and 1974, when Munger's partners lost about 53% over those two years. By comparison, Pabrai is doing quite well.

(How did Uncle Charlie's story end? In 1975, Munger's partnership earned a 73% return. When Munger liquidated the partnership, he had compounded money at just over 24% for fourteen years, even through the 53% two year decline.)

Pabrai's Presentation

Mohnish Pabrai talked for about 30 minutes or so (could have been longer...I wasn't watching the clock) and then opened the floor up for questions. (He won't discuss current or prospective holdings; so, I couldn't ask some of your questions.)

Pinnacle Airlines. Mohnish admitted that he would have been better off spending $20 on a book than $20 million (or whatever the real loss was) on Pinnacle. Airlines are tough, and Pabrai admitted that he should have learned from Buffett's lesson (or "beating") on US Air.

The takeaway lesson on Pinnacle. Airlines are typically bad businesses to invest in. Like auto makers, airlines have thin profit margins, suffer from high capital expenditures, and have to compete on price. Most investors should stay away from airlines entirely.

Investing in China. I'll give you the "short short version" of Pabrai on investing in China:

It is said that they maintain three books: one for running the business, one for the government...and one for the owner's wife.

Pabrai does not plan on making any investments in Chinese companies (though I don't think he'd rule the right opportunity out just because it's in China). Instead, he continues to believe that there are plenty of opportunities in the US.

Delta Financial (and other financials). Pabrai said that the big mistake he made on this one was not figuring out the "lifeline" for Delta. That is, he didn't properly assess the outs for the company and his investment. He then had this to say about Delta and the financial crisis (as well as all debt):

If you depend on borrowed money, you have to worry about what world thinks of you everyday.

(This was actually a quote ripped from Buffett at the Berkshire annual meeting on May 3, 2008. I give an example of this "borrowed money" danger in this post.)

Think about it personally — until your house is paid off, you have to worry about what the banks think of you. If you carry credit card debt, you have to worry that your interest rate will shoot up because the credit card company's opinion of you and your "creditworthiness" has changed.

Back to Delta: Mohnish said very simply that he did not consider the fact that the credit/securitization markets would completely freeze up. In short, he was "unprepared for a 1 in 50 year event."

Berkshire Hathaway. Over the years, Pabrai has been using Berkshire as a "placeholder" of sorts for up to 10% of his portfolio's cash. He'll hold it for a few days to a few months, and figures that he's averaged about 12% a year on it. (Beats the heck out of cash!)

He also talked about Buffett and Munger's amazing ability to compound money, "adding a zero every ten years." That is to say, every ten years or so, they added another zero to Berkshire's price ($40 to $400 to $4,000 to $40,000).

A Change in Strategy

Pabrai did talk about making a change in his strategy over the past year or so. He is now focusing more on the jockey (management) than the horse (cold financials). I took it this way: Up until a year ago, Pabrai was more than happy to "cigar butt" invest — find underpriced assets regardless of their quality.

Today, he is shifting to a more 1980s Buffett-style approach — find strong businesses run by highly talented, shareholder-focused managers.

Pabrai's Current Portfolio

Looking at his portfolio, Pabrai sees the widest discount to intrinsic value today than at any other point in the history of his partnerships. Some positions are trading at just 25% of his estimation of intrinsic value.

What will cause convergence of price and value? Pabrai talked about two types of assets in the portfolio:

  • hard assets and book value;

  • future earnings streams and cash flows.


Hard Assets — the Frontline Example

When Pabrai purchased frontline, the market value was less than one half of the liquidation value — a situation that cannot persist forever. Eventually, that price must correct because:

  • Wall Street will recognize its mistake in improperly pricing the business; or,

  • Someone will also recognize that value and begin buying, pushing the price upwards.


If the business is generated positive cash flow every month, that gap between price and intrinsic value widens every month. The widening of that gap puts tremendous pressure for the price to move up.

As Mohnish put it, "It's Ben Graham 101." Eventually market value (price) and intrinsic value will converge.

Future Earnings Stream as a Value Driver

In this case, Mohnish used IPSCO as an example. He bought the company at less than three times free cash flow. Thus, if the price did not change in three years, the market cap would be less than the cash on the books of the business.

What does that mean?

Plants, Inventory, Future Earnings Streams, Growth, Management, Permits, Licenses, Talented Employees — all free!

That "obvious" value caused tremendous pressure for upward movement in price. Pabrai bought for $45 and sold for over $155.

(As an aside, Pabrai said many of his holdings are trading at low single-digit multiples of free cash flow.)

The Pabrai Meeting Summary

All in all, it was a wonderful meeting and evening. You might think that Pabrai would be sheepish or cautious considering his recent performance; but, seeing the man in person, you can easily see that he believes his recent performance is not a problem in strategy (a strategy with a long, successful history with many mangers throughout history) but a problem with market prices and action.

Regrettably, I missed the Warren roundtable. At the end of the evening, Mohnish sat at a table with ten or twelve other attendees (whoever wanted to) and discussed his experiences at lunch with Buffett. But, I'll end with some points Mohnish had thrown out about Buffett earlier in the evening:

1. Buffett is a very reasonable person — full of energy and passion. As Mohnish put it, he's the type of person that comes along once in a century, like Einstein or Ben Franklin.

2. Warren Buffett posited: In investing, you have to make tough choices. As a non-investment example...would you want to be the best lover in the world, but have the world think you're the worst? Or, would you rather be the worst lover in the world, but have the world think you're the best?

3. Finally, do what you love.

And I'll add some wisdom to that last one — wisdom that Buffett surely implied and that my father always told me:

To be the best at what you do, you have to do what you love. And if you're the best, the money will follow. And that's true whether you're saving lives or digging ditches.

About the author:

Joe Ponzio
Charlie Tian, Ph.D. - Founder of GuruFocus. You can now pre-order his book Invest Like a Guru on Amazon.

Rating: 3.4/5 (51 votes)

Comments

commodity
Commodity - 8 years ago    Report SPAM
He really cost people a lot of money.

I am all about making money.

How about you ?
graham_jeffy
Graham_jeffy - 8 years ago    Report SPAM
you'd think if Pinnacle Airlines was such a poor investment(mistake) he'd unwind more than 3-4% of his holdings in the company.

I'm still curious to see what the market cap for this stock will be in a few years.
Sivaram
Sivaram - 8 years ago    Report SPAM
If I may play Devil's Advocate...

Finding good management may be tougher than anything. I'm not sure how one is supposed to pursue that strategy. It was not even 3 years ago when Hank Greenberg (of AIG) would have been considered one of the top executives over the last 20 years. After all, ignoring Spitzer's legal attacks, he built up AIG from a normal insurance business to arguably the top one in the world. Yet, AIG collapsed due to CDS insurance written (what seems as if) during his watch.

Let's also not forget that Jeffrey Immelt of G.E. was considered one of the top executives (even Buffett said that.) But, yes this is just short-term, GE is off 50% this year and market is pricing in huge declines in future earnings (most of which come from financials, although nothing to do with mortgages.)
David Pinsen
David Pinsen - 8 years ago    Report SPAM
Joe,

"Think about it personally — until your house is paid off, you have to worry about what the banks think of you."

This isn't a great analogy. As long as you pay your mortgage payments every month, you don't have to worry at all about what the bank thinks of you.

Sivaram,

"It was not even 3 years ago when Hank Greenberg (of AIG) would have been considered one of the top executives over the last 20 years."

Greenberg did an impressive job of building up AIG into a huge company over a few decades. Some have argued that if he had still be running AIG over the last couple of years -- if Spitzer hadn't forced him to resign -- AIG would have avoided its current desperate straits.

"Let's also not forget that Jeffrey Immelt of G.E. was considered one of the top executives (even Buffett said that.) But, yes this is just short-term, GE is off 50% this year and market is pricing in huge declines in future earnings"

In some ways, GE is a microcosm of the U.S. economy. Like the U.S. economy as a whole, the financial component of its earnings became too large. That was due largely to the structure of GE when Immelt took over. As with the U.S. economy, GE will have a difficult adjustment period, one that will include an increase in its manufacturing business and a decrease in its financial business. Buffett probably still thinks highly of Immelt.

Sivaram
Sivaram - 8 years ago    Report SPAM
DAVE: "Greenberg did an impressive job of building up AIG into a huge company over a few decades. Some have argued that if he had still be running AIG over the last couple of years -- if Spitzer hadn't forced him to resign -- AIG would have avoided its current desperate straits. "

First of all, I'm not an expert or anything but I think Greenberg deserves to go into the insurance hall of fame (I don't think such a thing exists but you get my point.) He was very good.

Having said that, I have seen those references to what you are alluding to (i.e. AIG wouldn't have gone down with him in charge) but people fail to realize that the CDS-type insurance was written many years ago, when he was running things. One could perhaps argue that things got even worse after he left, but the fact of the matter is that he is the one who pushed AIG into credit default swaps and AIG would have taken losses on that stuff even if he were in charge.

Now, where people are right, is with respect to what actually happened in the last few months. Namely, the nationalization of AIG simply because it couldn't post collateral--this isn't even actual claims, but simply collateral. I am certain that there is no way Greenberg would have been as incompetent and sit on an issue that could bring down the whole company. But even some guy off the street like me would have tried my best to avoid that.

So, the collapse probably wouldn't have occurred under his watch. But AIG would still have taken massive losses on their CDS insurance. Anyone investing simply because of Greenberg would likely have lost huge sums. Not an almost-complete loss as now but still a massive loss.



DAVE: "In some ways, GE is a microcosm of the U.S. economy. Like the U.S. economy as a whole, the financial component of its earnings became too large. That was due largely to the structure of GE when Immelt took over. As with the U.S. economy, GE will have a difficult adjustment period, one that will include an increase in its manufacturing business and a decrease in its financial business. Buffett probably still thinks highly of Immelt. "


Yep... you are right. Buffett still likes him; otherwise he wouldn't invest in G.E. right now.

I kind of disagree with your GE as being a proxy for the US economy. The US economy is actually doing ok. Not great but not terrible either. For instance, Canada, as well as some European, countries have posted negative GDP numbers whereas the US numbers are just close to zero (it may get revised down later though.) My personal view is that GE is not what it seems. It isn't a proxy for hte US economy anymore. The main reason is because they earn something like 50% of earnings (or maybe operating profits?) from the financial divisions. This has been the case for more than a decade (although I think the numbers may have been a bit lower back then.)

I don't follow G.E. closely so this is just going out on a whim but I suspect that it is going to take a while before G.E. can turn itself around. A company that has been satisfying the stock market largely through financial profits may have a hard time diversifying itself. Jeffrey Immelt may be good but I suspect that this will be a case of an investor losing money on a business even with a good executive. It remains to be seen. (for what it's worth, Immelt inherited everything and he isn't responsible for the super-high concentration on financial profits. Jack Welch's reputation is going to be damaged a bit when all is said and done.)

Pabri switching strategies seems to go against my views (but I'm a contrarian and not a good investor :| ) The strategic switch should have happened an year or more ago, when management would have mattered (those that navigated the credit bust successfully would have paid huge dividends.) Right now I don't think the executives matter much. Macro factors are going to hit the businesses no matter what... having said that, Pabri is a skilled investor and he navigated the bear market in 2000-2002 well so he may do well. I'm skeptical of the strategic switch however...

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