This is the Part II of Tom Russo's talk during the 3rd Value Investor Conference.
I'd like to own what you see when you open up someone's kitchen cupboard, and you see all the brands that are lined up…
... And they're there for a reason, but they may not even be able to explain to you. But my goal would be an investment in all of those that show up regularly.
Weetabix shows up in every British household. And it's based on the advertising.
Even grown adults, when asked, "Do you have Weetabix?" will answer (because one of the messages is that it has something good for you, it somehow fortifies you for the day's events) "No, I'm getting busy, so I tend to eat on the run. But if I have an important meeting, I'll have my Weetabix." And just that kind of legacy that endures is what you really want to find in the investment.
QUESTION: I love Weetabix as a customer because it's available here and it's in Europe, you can have it wet, you can have it dry. But how would you buy shares today?
TOM RUSSO: Well, you can't. Let me give you the final story. As a money manager who's American, I have to fight cultural preferences. I do manage some but not much institutional money. Most of my clients are families. But, you're at a committee meeting with an institutional client and they have a smart adviser and you start to talk about Weetabix. I remember one guy said it's the worst tasting product, tastes like sawdust and the whole litany of complaints. He actually suggested that it might be used for soaking up oil spills in the North Sea because it has the ability to absorb infinite amounts of liquid.
But you had this issue--many investors would say, "Why on earth would you own that stock? Because the product tastes so bad, who would eat it?" My only comment is that the British have to eat it and they have to stay loyal to it and stay with it as a brand. If that's the case, then you have a pretty steady business. Now, this company was able to innovate, they were able to make some acquisitions of adjacent companies, and they were able to price and grow brand share over the ensuring eight years. By 1997, the EBITDA had grown to 52 -- we'll pick up in '98, it had grown to 63 million pounds. The cash had grown to 65 million pounds. They still said the business was worth eight times EBITDA, and their intrinsic value had grown to 47 and the share price had gone to 37. The interesting issue about being a value investor is I bought it with a comfortable discount from intrinsic value. The discount remained, it wasn't quite so deep, but it was certainly, from my perspective, deep enough to continue to hold the shares.
During this period of time, the compound annual return from this was about 27 percent. It was far higher than anything I would imagine and certainly above any kind of average that I've enjoyed over any period of time. But it was driven by the growth in EBITDA and buildup of cash.
I didn't sell many shares. Then the Internet came along, and people started to worry more about computers than breakfast cereal. Wal-Mart entered the English market, so they started to put pressure on brands, and they started to pressure Weetabix. So to respond, Weetabix had to increase their advertising, which took some of their EBITDA away. They had to increase their spending on product innovation to defend against copycat knockoffs of their old brand.
In the process of fighting the potential threat as a Wal-Mart subsidiary, they flattened out their EBITDA for the next five years. In the meantime, the shares dropped all the way down to 19 pounds. As a value investor, you have to live through periods of under performance if you're going to out perform in the long period. But it's particularly hard when, in this case, for example, your U.S.-based investors, as they saw their shares decline from 37 to 19, were empowered in their criticism of your investment because the product was so foul tasting. It was very easy for them to say, "Well, not only are you losing money, but it's a stupid idea because the product stinks."
My feeling at the time was they were investing in their business to try to support it going forward. They were consuming some of their up-front profits in the process. The business continued to have viability, and their cash continued to grow, it was up to 80 million pounds at that time. All of the checks that I had suggested the business had viability, though the shares had in the meantime proceeded to drop by 50 percent. At the low, which was just between these two periods, it hit 19 down from 37. The interesting thing is that by the time it reached its low, the compound from start to finish had declined to 10 percent.
That's what I look to do. And the reason why, even with that big sharp decline we were still at 10 percent, is that the EBITDA grew at roughly 10 percent over that same period of time. So the link that exists between stock price performance and growth and value was what supported the performance even with that sharp decline. But at this time, the business was trading at two-and-ahalf times EBITDA.
Along came Hicks Muse, a leveraged buyout firm, and figured out that at 54 pounds or roughly 8 times EBITDA plus all that cash on the balance sheet, they could probably acquire the business. And they did, so that was the end of the public market investment in Weetabix. Now, this is a family-controlled company. And one of the pitfalls you face in investing in any family-controlled company is that they may not look at the capital structure with as much thought as you might. So in this case, even when they had a hundred million pounds of cash, I couldn't encourage them to buy back stock. So they had 11.8 million shares outstanding at the beginning and all the way through to the end. The good news was they weren't diluting our investment by offering 2 or 3 percent of the stock to management through options every year. But the bad news is that they didn't take advantage of what would have been a home run by taking out of the market shares at a price that reflected the market's focus on more sexy Internet company shares and its paranoia over Weetabix poor short term results.
Had they started buying back shares at 20 pounds a share, they would have retired 5 million shares, which would have taken the final number down to 6 million something. And the price would have remained the same, eight times operating cash flow of roughly 63 million would have still been 500 million pounds, but it would have been on the basis of far fewer shares, and instead of paying us 54 pounds, it would have been something closer to 75 or 80.
It just would have been the mathematics of having taken shares off the market. It's sort of a hypothetical, because they couldn't have picked up as much stock as that, because I owned 17 percent of the company, so those shares were out and the family-owned stock. They wouldn't have been able to find a full 5 million shares to reclaim all their money, but they could have found some, and it would have made our investment, I think, pay off more forcefully at the time had they been able to do that.
QUESTION: Do you find any difference in the American subsidiaries of foreign companies taking suggestions from activist shareholders?
TOM RUSSO: I'd have to say yes, but I would find that I'm equally unable to persuade American companies to do that, as I am foreign companies.
But I would just jump forward to some of the observations what we'll end with by saying one of the things that's changing in international investing is the growth in renegade pools of activist capital. So I'm a believer in the management-friendly style of investing.
So with that as my mantra, I tend not to be a very effective activist. When the business is well run and when they're at least neutral with cash, we're not in trouble. Because in this case what they didn't do is something smart with the cash, but what they most importantly didn't do is blow the money.
Let me share with you another global value stock pick, the Dutch newspaper De Telegraaf.
There's another company I like to talk about, de Telegraaf, which is a Dutch newspaper -- which I've owned over the same period of time -- which started life with a lot of cash and a relatively low EBITDA.
At the time I started investing in them, they had a lot of cash on their balance sheet. It's a bit difficult to consider newspaper cash their own cash because they did have subscriptions prepaid that fall into this line called cash.
They were very liquid, in any case, and trading at a relatively low multiple of its EBITDA. They had 52 million shares outstanding to begin with, and fortunately still today they have 52 million shares outstanding. At some point with their cash and growth, it was two hundred and some million shares outstanding. I just couldn't pound on their heads enough to get them to take some of that cash and buy back stock. But instead, they made all sorts of bone-headed acquisitions because they thought that their mission was to build the business.
They started out with magazines in Sweden, then they bought another newspaper in Holland, and they spent a lot of money on a new plant. They effectively managed to squander the cash that they had generated through their core business, which was an attractive business.
They didn't buy back stock, and more detrimentally to the investor is that they wasted the money. Fortunately the business franchise has survived. I stayed with the investment. It was relatively lackluster, because during this period they were squandering our money. As I started all the way back in the mid-80s -- and I went to Europe in part because the U.S. market was consumed by leveraged buyouts, and the valuations in Europe were less full because the businesses like newspapers, capable of setting cash flows, were under recognized by the market (absent Buffett's lessons) and capital pools didn't flow and they didn't like leveraged buyouts.
Now you've got leveraged buyout pools throughout the world and Kohlberg Kravis Roberts & Co (commonly referred to as KKR) acquired a European television broadcaster recently called Scandinavian Broadcast Systems. And in the Dutch market, Telegraaf had a 27 percent stake in that business, so they now have converted their stake to a share of KKR’s private mortgage company.
That was the start of a good thing, because rather than owning just a piece of a stumbling Dutch broadcaster, we now have a share of an European-wide entity that has a proper capital structure, more leverage, that's run by the talented folks that KKR had brought in. I think we'll make a lot more money being a participant in a leveraged equity than we would have if I stayed as a minority holder in a Dutch only TV station. We received those shares, and that's a good development.
More importantly, in Holland, you had CSM and you had VNU and you had three other companies, which all had historically controlled boards and often had controlled family share holdings suffer at the foot of activist shareholders.
And the management finally went back to the control family and said, "If you don't wake up, you're going to be awakened by an activist pool which will come in, and they'll simply strip this business and take all the value of the stock that's massively under priced. You can do it or they'll come and do it for you."
It's only been just recently that the changed environment has come to impact our interests favorably. It was from two forces. The first force is the growth and leveraged buyout pools affecting European companies. So this family recently decided that they'd sell a non-strategic asset, a newspaper. Then another leveraged buyout pool of money came from England run by a former English newspaper leader named Montgomery, and they paid twelve and a half times EBITDA to buy a newspaper in Holland, and two hundred and some million euros in cash flowed into the company. It was at the time when we [Telegraaf] had a market capitalization of 900 million.
For one small paper, they were paid 200 million. And the family then agreed for the first time ever to deploy some of that cash to buy back stock. This was a dud. And it was a dud not because they issued a lot of stock through options, because they just -- they kept that flat, not because they couldn't generate cash, but because historically they just didn't think about share buy back as a use for cash, and they felt it sort of imperative to spend the money, and they spent it unwisely.
The future is better because I think they're under a much shorter leash, not because I police them through my entreaties (because they were deaf to my recommendations over all of those years) but because the market has finally gotten new factors for leveraged buyout of pools to purchase those businesses and the activist pools to frighten those managers.
Company Specific Investments
That really leaps me forward. I would say how I invested abroad -- I'll just race through a couple more points, and then I'll open it up for questions. Brown Forman led to James Burrows. James Burrows is in one group of investments as an American you might make, and those are what I call company specific investments. I'd say Telegraaf is company specific. Weetabix was in a sense company specific. One way you find out about those is do exactly what Berkshire's chairman said that he did when he invested in Korea. You get a country guide, which in a very simplified fashion describes what the companies are that are public in the market, and you just thumb through it and look at the numbers on a standardized format. You'll see interesting businesses that exist in just local markets.
I knew about Weetabix from my wife's tastes. But in France, there's a company called Talc de Luzinac which I owned at one point which was the largest talcum powder producer in the world, very specific, very local, public, and cheap at the time.
In Argentina, there is a brewery called Killman's. It was sort of a loose affiliate of Heineken and a family of great standing. Something I discovered just by thumbing through country guides.
Country Specific Investments
So anytime someone says to me, for example, “The Norwegian market collapse” I'll give a very brief look at this investment. These are countryspecific investments.
Let's take a look here. A colleague of mine went to Williams College with a Norwegian from a prominent family. In 1991 the Norwegian market collapsed. It collapsed because of the conflict in the Middle East. The Suez Canal was closed off for shipping; the petroleum shipping that took place there ceased.
The Norwegian economy is extremely leveraged to oil, mainly because of shipping. And all of the ships were owned by families privately through leveraged pools they call some kind of KF funds or something, and extraordinary leverage to generate tax deductions to sheltered income from the very high tax rates that the people in Norway face.
The moment one of these ships goes dry, it goes into dock and comes off service, they go bankrupt. Because they're so leveraged that if they're not engaged, they immediately go bankrupt. Note that in Norway, there's no personal bankruptcy. So once the ships started to fail to provide commerce, the clock immediately starts ticking because you had to fund those investments out of other holdings. That process led to a collapse of the Norwegian stock market and was directly related to the Gulf War. So you said, "Norway's collapsed. What should we do?" My answer is, "Let's buy the newspaper." So I went over, and this one here was the Wall Street Journal of Norway, and a complete free fall. And this is 1991--$21 a share.
With global value investing you need to decide if you are going to hedge currency
A very interesting observation about this particular investment: One of the things that you either decide to do or not is hedge currency. And since I said at the start that I was sort of interested in providing some currency exposure through investing abroad, I'm clearly not presenting myself as fully hedged. Some people do. Some people have a practice that the only thing they are interested in is businesses abroad. They say, “We don't care about currency, we hedge every single investment. In this case, you couldn't have made that investment because the market was in such a free fall in Norway that there was no foreign market for hedging the currency. The interest rate differential was just so great that it wasn't practical to hedge.
Going into the investment that we made in Norway at that time, we knew that, and we knew we'd lose a lot of money to the currency because the market was not clearing, the pressures were that the crown would collapse; you couldn't hedge it.
But the investment was priced accordingly, because the same factors that led to the inability to hedge the currency were extremely high interest rates, but they also led to extremely low equity valuations.
We bought the shares and immediately suffered substantial currency declines. But over time, the discount in the valuation of the business, this regular business of the local Norwegian Wall Street Journal was sufficient to offset the currency, in fact. The result was sort of a seven-bagger over approximately fifteen years. It's probably a modest, not outrageous compound, but it was an example of yet again the first class of investments which are country specific.
You can't imagine anybody thinking about an investment that's less interesting than a Norwegian newspaper with 3.7 million potential readers in the world and no prospects for global growth. But that said, you can find very attractive businesses by thumbing through country guides and looking at just the specific investments within a given country.
Another area that I've used as an area of focus would be what I call the global brand leaders.
And those are pretty obvious. That's Nestlé, Heineken, Unilever, Cadbury Schweppes. If you're looking to get brands that are entrenched, that are legacy, there's really no better way to do it than someone like Heineken which has been in emerging markets for 35 years, or Nestlé that have had plants around the world for a hundred years.
Even Unilever and Cadbury have followed the British Empire around the world. They have terrific legacy brand value, and I own all of those with the idea that those branded positions enjoy sort of consumers in reserve. Because all the people who are aware of those brands during the periods of time when it had very little income, very little spendable money, discretionary spending, coveted those brands but couldn't afford them.
As the economies in India, China and the rest the world begin to prosper and discretionary spending goes up, some of the earliest luxuries that a consumer can afford are those brands that they couldn't afford before.
Global brand leaders are pretty apparent.
The third area that has been very helpful for me has been subsidiaries of global brand leaders
I look down the list of some of my investments over time, Allied Domecq, which was originally called Allied Lions, had an Irish tea company called Lion's Irish Tea, and they had a British -- I'm sorry -- a Canadian liquor company called Corby Distillers.
Now, both of those businesses were public in their home markets. Even though they were controlled by Allied Lions, they were public in their home markets because of something called the Foreign Investment Requirement Acts that exist in so many countries.
If you want to participate in a country as a foreign company, you were often required to leave a public stake outstanding in that market so that the locals wouldn't feel like they were being colonized. Those shares are issued under something like the Foreign Investment Requirement Act, maintaining a local presence. But there's no requirement that those shares have to be owned by local investors.
So I have again and again and again participated in markets in businesses that I like, cashgenerated businesses that are run by the global leaders with western tax treatments, western managers, and western style accounting. That way I'm able to participate in a market like -- well, neither Ireland or Canada concerned me -- but in other markets such as the Czech Republic, which I visited in the early '90s.
Now, while I came away with an investment in Philip Morris' Czech subsidiary, I couldn't in good conscience invest in almost all the other businesses I saw there because of the fear over the market, the rule of law of corporate governance. The former Communists who ran all the businesses, they just didn't impress me as the type of people I'd like to give my wallet to and ask them to give it back sometime later with more money in it. It just didn't impress me as such.
But I chose to participate in a market that I was sure would grow, which was the Czech market, because they have such a history of success in business, through a company such as Philip Morris Czech Republic. Now, this investment hasn't had the same appreciation over the years as has Philip Morris, its parent company. It's worth noting that one of the drawbacks of investing in the single market subsidiary of a global enterprise is that things happen. Indeed, the Czech market has increased disposable spending, and so the share of the Czech market of local products that Philip Morris still produces has gone down as their international brands have gone up and had higher prices and higher margins. So that has played out. But other things have conspired to dim the returns offered by this investment.
One of them is that as a part of the Altria universe, when Altria [parent company of Philip Morris] wants to list company's dividends and this company is not allowed to reinvest their Czech market cash flows into Uzbekistan or into the markets that are growing outside of Czechoslovakia in the same region. Even though we have knowledge of the markets, Altria retains the ability to invest directly in those markets. The Czech subsidiaries are Czech only.
As a result, when they develop abundant cash flow, in order to get at that money, the parent has to dividend it out. And they get an 85 percent tax exclusion on that dividend, but we'd have to take the dividend. So over the years, this business has paid out dividend incomes that have averaged over 13 percent.
At the moment, the dividend is still 9 percent. I'd much rather as an investor not have taxable income, and I would much rather they took every dollar of free cash and bought back the shares or done something to increase the compound. We had an extraordinary dividend deal from that investment all along, but we hadn't been able to re-employ the capital into growing into other markets that were adjacent, and we paid a lot of taxes unnecessarily. So that's one of the pitfalls.
The other thing that's interesting about the third area that I have participated in, which is this global leaders local market subsidiaries, is you can become a pawn in a couple of factors. One factor is that Altria originally used the facilities in the Czech Republic to produce for the Russian market. They would ship across the border to Russia.
At some point, they proved up the market and the Russian market built a facility that they then needed to shift the production to. We lost absorption. Russia developed its own product and therefore the Czech market suffered. That's one aspect, the other is the global battlefield can sell on you for reasons that are non-Czech. So for example, if Altria goes into Italy in a way that upsets its competitor British American Tobacco [BAT], BAT may respond in a disruptive way to the Czech market that our company has to respond to at the expense of earnings that are specific to this market.
Over the years I've invested in several global markets. One of them was in the Irish market, and it was called Readymix PLC, which was a construction equipment and crushed stone company. And it worked fine. I've owned Readymix since the early '90s. It paid a little dividend, it's grown well, and yet it's just exactly what I was referring to before, it couldn't grow with other markets and it's Global value investing, in general, is an interesting way to invest, but it does come with some pitfalls. very controlled because the parent of Redi-Mix Corp controlled the rest of the market that they otherwise might have coveted because of adjacencies.
I visited with Readymix in the early 1990s. It was very, very cheap, but it was controlled by a foreign company. I was comfortable that it wouldn't have local market issues. But its counterpart, CRH, the international building materials group, has been an absolute growth engine, and it's grown well beyond the Irish market, because it's Irish based, and they looked upon the rest of the world as their oyster. I'd have been far better off in that particular instance buying CRH at a roughly equivalent value but the allowing the compound of that reinvestment to move us farther along as they built a global empire.
Readymix has just sort of stagnated in its local market. It was statistically cheaper than CRH, but it hasn't had the same growth because dividends were paid out and its marketing opportunities were constrained by the local market.
Then you can try to be a little too clever
For all of these years, I tried to find local subsidiary ways to play the great global leaders. Every time I met with Coca-Cola in the early 1980s, I'd say, "Well, tell me about the markets. You have local subsidiaries, tell me about the markets." And, of course, Coke just soared during this period. I was in search of the perfect small market play on Coke. I'd have been far better off at that point just buying the global leaders.
The last point I’d state is that if you want to be a global investor, there’s absolutely no reason why you’d ignore American companies whose greatest prospects are foreign. So in this portfolio, I would include among them Brown Forman [nyse:BFB]. I initially invested in Brown Forman, a wine and spirits company, back in 1986 time frame when it collapsed and led me to James Burrows, and I invested then. In 1986, Brown Forman may have done 4 million cases a year of Jack Daniel’s, 3.5 million of which were U.S. They're now up over 7 million, and the additional three and a half million cases have all come from foreign markets. It's all come at much higher margins than the U.S. markets.
Throughout this period of time, Brown Forman has been willing to sacrifice near-term earnings to invest in the startup of those international markets. So investing in Brown Forman in the U.S. with U.S. law, and I know the people, I know where they went to school, I know what their values are, I'm still able to capture enormous global growth.
So I would say it certainly is the case with Brown Forman. And in their case, one of the reasons the investment has performed as well as it has is even though it's family controlled, they understand what it means to buy back stock. Over this period of time, there have been three periods when they bought back 15 percent of the shares when they were mispriced by the market. As a result, the remaining shares enjoyed a leveraged return, the last time about three years ago with interest rates at three and a half percent, to buy back several hundred million dollars worth of stock. Only now, just as an aside, have the European companies begun to consider share buy back as a promising possibility.
They used these very cheap borrowed funds to buy back an under-priced share. And so that fiscal or corporate finance sophistication helped us in the investment where we never really had similar help from our foreign holdings. Another pitfall that I'll refer to is a fairly arcane and specific one but it's an intriguing one. I own shares of Heineken's holding company. Heineken's holding company is specifically tied to Heineken NV.
Heineken NV is an index listed and fairly liquid member of the Dutch index. At some point, the holding company shares – which have a one-forone relationship, which means for every holding company share, you have one share of NV -- the holding company shares have always traded at a modest discount because they're less liquid, they're controlled by the family, people worry that the family will steal from you somehow. About four years ago, following the creation of the European Union [EU], the pension assets in Holland were permitted for the first time ever to invest EU wide. What it meant was that the EU exposure that the Dutch pension funds wished to gain would come from indexing the largest German companies, the largest Spanish companies, and the largest Italian companies. For a time before then, the Dutch pooled their own Dutch stocks because they were required to own Dutch stocks in the pension funds. If they were stockholders, they had to be Dutch stockholders. So a portion of that money finally spilled down to Heineken Holding, which is less liquid and not part of the index.
Once released and the capital re-allocated, there was selling in the Dutch market of Heineken Holdings to free up that capital to go into the German index, the Spanish index and the Italian index. Therefore the Italians, Germans and Spanish came in and bought the Dutch index, which led the share price of those members of the Dutch index higher, while at the same time Dutch selling drove the share price of the holding company in Heineken lower. For a period of several years, the spread that had historically been 10 or 15 percent widened to as much as 40 percent.
Now, I'm a shareholder in Heineken Holdings. I look at that as opportunity to buy more Heineken Holding shares. But the pressure was for factors that relate to the macro world.
And you'll see time and again as you invest abroad that there will be macro factors
A couple of those over the time that have helped boost my investment returns. Another was the world health scare of SARS and the Asian based avian flu and their impact on China and Asia-related investments.
As Asian stocks declined because of the fear that China would become insular and set back, we were able, based on substantial investments in Richemont – the Swiss based luxury goods company, whose business suffered during the avian flu and SARS epidemic -- and we took advantage of what was a crisis at the time. At the same time, Altria, my largest holding, sent the chairman over to China at the time when most of the world sort of avoided China. He came over and said, "We're with you through thick and thin."
The Chinese government appreciated that expression of support, and some years later gave Altria the only contract, legal contract, to develop a manufacturing presence in China and to develop a relationship with the Chinese monopoly to sell Chinese brands abroad. The opportunity to strike during a period of crisis definitely exists, and that was an example.
Let me share with you some of the pitfalls of global value investing
One major pitfall is language and culture. Very close colleagues of mine took me to Korea after the '98 currency crises. The Asian markets suffered from too much capital flows, over building and then the collapse of their currencies.
In the midst of that, we went to Korea. And, you know, I was extraordinarily frustrated because I was literally at the mercy of the interpreters, which is yet another pitfall. I very much tried my best to understand the specific factors of which I made an investment and went to the Lotte Confectionery Company, which is just what I wanted, it's a confection company in a decent market.
We sat with the vice chairman and spoke for almost 45 minutes. I asked a question about the following year's cash flow. The interpreter and the vice chairman spoke for about 45 minutes, at which point the interpreter said to me, "Better." I sort of threw up my hands. Because all of that dialogue, I didn't know if they were talking about their golf game or what they were doing. But if in talking they were talking about the ingredients that supported the conclusion "better," what I heard back was "better," and that wasn't enough. As a result, I was somewhat dismayed by the culture and the language.
I remember at the time, there was also a great bankruptcy that occurred with a company called Hinix, and there was a photograph of the chairman being led off in chains, and he had a terrific suit on, he had a heavy, blue, full-length cashmere winter coat, and then sort of below his knees he had this pair of high-top Reeboks with, you know, all of these vibrant stripes and everything else.
Looking at that photo I realized that I just don't understand a country and a culture where they can be all dressed above their knees and then down below, you know, in public in a professional setting wear high-top Reeboks. I couldn't quite get my arms around a culture that would have such contrasts apparent. But those things led me astray, because the market is up probably twelve-fold since '98 when I passed for cultural reasons. So I just think you have to be awfully careful when investing outside your own country, language and culture.
Let me take a few moments to share my thoughts on some interesting current issues – one being corporate governance standards
Americans are trying to hoist the Europeans with our corporate governance sort of trends. I own a large position in Nestlé, and Nestlé's CEO was nominated by its board to replace the chairman a year and a half ago, for reasons that are quite specific. The board had a recent expansion with many, many young and recent tenured board members, and the board felt that with lacking experience, they wanted to have the CEO who was a board member appointed as chair to see them through the period of time.
At the same time in the executive committee, there were also a whole series of changes. That meant as a CEO, he felt uncomfortable relinquishing the title. There were enormous amounts of business integration, global management change, and he felt uncomfortable giving up those responsibilities at a time when his executive committee at that particular time was a very young tenure. Rather begrudgingly he accepted the joint position with the condition that it would be temporary.
In the USA, Institutional Shareholder Services [ISS], providers of proxy voting and corporate governance services to institutional investors, and others in North America mounted a charge against Nestlé because that was going towards the American model that they resist and away from the European model of non-exec chair.
The American investors of Nestlé began to speak, uniformly agreed with Nestlé that they were comfortable with the reasons that the chairman and CEO would rest temporarily in this one person, in particular because this person happens to be extraordinary. Nestlé's history over 80 years is that they only had a joint position like this I think less than 12 years out of 85 or something. It's quoted on the history and the pattern of conduct.
The American shareholders, who all agreed with Nestlé at the same time, then said that they would vote against it, because as long as the proxy consultants in North America said it was against corporate governance best practices, they felt as money managers unwilling to go against that, because it shows in order to take a stand contrary to an ISS or someone like ISS's perspective, you have to have such paperwork to comply to meet the standards of disagreeing. It's a hurdle that no one was willing to take, even though in conversations with management, they concurred with the wisdom of that way.
That shows you there's a growing reach of corporate governance that not necessarily will lead to better outcomes
Heineken had the same thing happen. I've talked about the Heineken Holding Company versus the Heineken NV. The holding company, family controlled, controls the NV, and has given the NV the patience to invest for the long haul, the patience to take investments that don't pay off soon but will pay off not short-term rich but long-term rich, and Heineken has succeeded over the years by having that stable capital structure. A western shareholder tried to dislodge that by insisting that they collapse that structure. I believe it's added value not detracted value. But the world of corporate governance is converging around the international holdings. The good news on share re-purchase is that it's become much more frequently used abroad.
For example, Nestlé announced a $5 billion share re-purchase in the last year, having never had one before, and it reflects their view that the opportunity is compelling in light of the market's undervaluation.
On another front, the stock option successes in the U.S haven't surfaced internationally. As I said at the start, I felt that they've been more patient as executives in looking out. But the stock option abuse could lead to more short-term conduct. It really hasn't kicked in. The rising pools of activist capital have helped me in Telegraaf, and the appearance of the leverage buyer capital helped Weetabix. It hasn't helped; it took away Weetabix, to be specific. But the valuation level in general goes up because there are pools of capital willing to commit to privatize businesses when they're out of favor.
Many of my investments sell consumer products, and as a result they are increasingly selling through ever larger global retailers. So as a phenomenon, I worry about pricing pressure and the inability for my manufacturers to appeal to their consumers through an increasingly consolidated retailers environment, which increasingly has power to threaten to delist their products from their shelves if they don't agree to tougher terms. So that's a world that I inhabit and another pitfall.
One last thing I'd say before your questions, is, the threat of counterfeit. Since I invest in the world of intellectual property, brands, trademarks, is something that's very timely. It's a critical issue as time goes forward. And, as I described at the start, global investing is 40 percent of my day. So I've given you a sense of how I spend 40 percent of my time and what I care about and how I've gotten there.
That concludes my prepared remarks about Global Value Investing, now I will be happy to answer any of your questions.
QUESTION: Coming back to your Weetabix example, how high will you go with one stock as a percentage of your portfolio? When the price rose and your percentage of ownership increased and your margin of safety reduced, were you tempted to sell or reduce?
TOM RUSSO: I'm comfortable with positions as large as 10 percent. I won't typically go much beyond 10 percent, which reflects my lawyerly ways.
I believe that I can know what's important operationally for most companies, but I can't ever really know about the thing that is most important, which is litigation risk. So I stop around 10 percent.
Weetabix never got near 10 percent at market value. It ended up being 10 percent on take out, but it was never really that large of a position that I had to re-weight it. It was because at the start -- when you think about it, it was only 11 million shares times 5 pounds, it was a 60 million market cap when it started, got to something like 500 million at one point. The good news at the start is I had very little money demands, and so I could take advantage of it. At the end, every share I bought could find a home without worrying about weighting. So as far as the movement towards intrinsic value, I always felt that 8 times was too low, because most food company acquisitions have come at something north of 10. So 8 was conservative because I just never knew what the family might do. You know, the risk is that they can also disabuse your interest when they sell the business.
When this company was sold the chairman and the CEO stayed on to work with the leveraged buyout firm. My risk at that point was that I had no idea of the term structure of the compensation deal that Hicks Muse entered into with the family member who sold out his family, colleagues, as well as the public shareholders. So the risk of that occurring kept the multiple below what a public company typically sold for. So it never (at 8 times earnings) got close enough for me to feel the pressure. It was still trading at a 25 percent discount to intrinsic value. That's when I ended up with 16 or 17 percent of the shares outstanding and I just kept buying. It was hard because the clients, as I said, hated the products, and they didn't like to see the collapse that happened to occur at the same time when so much easy money was being made with Internet stocks.
It was one of those great moments where Weetabix would go down weekly and Cisco would quadruple daily. It doesn't get much worse than that.
QUESTION: What is your opinion of Budweiser [BUD]?
TOM RUSSO: It's more expensive than the companies that I have invested in the beer business, which is Heineken, and we own SAB Miller through Altria. I don't know what it is; it's $7 billion in SAB Miller through Altria. With Budweiser, I've been really impressed with their ability to create demand for their product abroad. Particularly in China, the BUD brand itself is developing a following, the Chinese like it. The market doesn't have enough margin yet to make any difference because the pricing is so low.
But the brand is there, and I think it's going to be a good factor going forward. I think you can -- if you just adopt a very long horizon, you probably would do well with Budweiser. But it just seems expensive in terms of the valuation.
The other thing is a bit surprising - it's not a family-controlled company. The Busch family, though in secure control of the business, really only own about one percent of the company. BUD is a bit quirky, and there's just some weird stuff. There's some weird family dynamics at Budweiser right now, Pat Stokes versus the young August. There's weird stuff, and that fight hasn't been fully fought.
QUESTION: What are your thoughts on the valuation of Berkshire Hathaway?
TOM RUSSO: Well, I think this week was an encouraging visit with management. I think what they've done is a couple of things. Warren Buffett and the Berkshire board of directors have wrestled with succession. And one way of getting that done is that they've communicated with the managers who run the subsidiaries personally through visits to the board, what it means to be part of Berkshire.
Berkshire’s culture comes back in a simple message, maintain and extend your competitive advantage or moat. We have more money than you'll need ever. But everything you want to do, come tell us, and if it's good, you'll do it because we want you to deepen and broaden your moat. Most importantly, at Berkshire the message is never do anything with our reputation, period, full stop.
Berkshire’s message of its culture has become far more prominently delivered. It certainly was so at the annual meeting. Shareholders’ concern then about succession, how would the firm succeed more and succeed after Warren I think is answered by the fact that the culture is now more front and center discussed and probably sustainable. It has to be so if, for instance, recently acquired, Iscar Manufacturing was willing to keep 20 percent of their business with the partner at Berkshire. If they felt that Berkshire was going to change course in midstream, they just committed corporate suicide if it were in fact that the business was going to be run differently with different values going forward.
The Iscar acquisition sent a big message that the values will remain. And so the fear over succession, I think, has been addressed, and I think that's been a weight on the stock price. Also the fear over what they can do with the capital has been addressed because they've just committed about $18 billion in acquisitions over the last 24 months.
Well I see that my time is up and I will be happy to stay after the break to meet each of you and answer any other questions that you may have. Thank you.
I'd like to own what you see when you open up someone's kitchen cupboard, and you see all the brands that are lined up…
... And they're there for a reason, but they may not even be able to explain to you. But my goal would be an investment in all of those that show up regularly.
Weetabix shows up in every British household. And it's based on the advertising.
Even grown adults, when asked, "Do you have Weetabix?" will answer (because one of the messages is that it has something good for you, it somehow fortifies you for the day's events) "No, I'm getting busy, so I tend to eat on the run. But if I have an important meeting, I'll have my Weetabix." And just that kind of legacy that endures is what you really want to find in the investment.
QUESTION: I love Weetabix as a customer because it's available here and it's in Europe, you can have it wet, you can have it dry. But how would you buy shares today?
TOM RUSSO: Well, you can't. Let me give you the final story. As a money manager who's American, I have to fight cultural preferences. I do manage some but not much institutional money. Most of my clients are families. But, you're at a committee meeting with an institutional client and they have a smart adviser and you start to talk about Weetabix. I remember one guy said it's the worst tasting product, tastes like sawdust and the whole litany of complaints. He actually suggested that it might be used for soaking up oil spills in the North Sea because it has the ability to absorb infinite amounts of liquid.
But you had this issue--many investors would say, "Why on earth would you own that stock? Because the product tastes so bad, who would eat it?" My only comment is that the British have to eat it and they have to stay loyal to it and stay with it as a brand. If that's the case, then you have a pretty steady business. Now, this company was able to innovate, they were able to make some acquisitions of adjacent companies, and they were able to price and grow brand share over the ensuring eight years. By 1997, the EBITDA had grown to 52 -- we'll pick up in '98, it had grown to 63 million pounds. The cash had grown to 65 million pounds. They still said the business was worth eight times EBITDA, and their intrinsic value had grown to 47 and the share price had gone to 37. The interesting issue about being a value investor is I bought it with a comfortable discount from intrinsic value. The discount remained, it wasn't quite so deep, but it was certainly, from my perspective, deep enough to continue to hold the shares.
During this period of time, the compound annual return from this was about 27 percent. It was far higher than anything I would imagine and certainly above any kind of average that I've enjoyed over any period of time. But it was driven by the growth in EBITDA and buildup of cash.
I didn't sell many shares. Then the Internet came along, and people started to worry more about computers than breakfast cereal. Wal-Mart entered the English market, so they started to put pressure on brands, and they started to pressure Weetabix. So to respond, Weetabix had to increase their advertising, which took some of their EBITDA away. They had to increase their spending on product innovation to defend against copycat knockoffs of their old brand.
In the process of fighting the potential threat as a Wal-Mart subsidiary, they flattened out their EBITDA for the next five years. In the meantime, the shares dropped all the way down to 19 pounds. As a value investor, you have to live through periods of under performance if you're going to out perform in the long period. But it's particularly hard when, in this case, for example, your U.S.-based investors, as they saw their shares decline from 37 to 19, were empowered in their criticism of your investment because the product was so foul tasting. It was very easy for them to say, "Well, not only are you losing money, but it's a stupid idea because the product stinks."
My feeling at the time was they were investing in their business to try to support it going forward. They were consuming some of their up-front profits in the process. The business continued to have viability, and their cash continued to grow, it was up to 80 million pounds at that time. All of the checks that I had suggested the business had viability, though the shares had in the meantime proceeded to drop by 50 percent. At the low, which was just between these two periods, it hit 19 down from 37. The interesting thing is that by the time it reached its low, the compound from start to finish had declined to 10 percent.
That's what I look to do. And the reason why, even with that big sharp decline we were still at 10 percent, is that the EBITDA grew at roughly 10 percent over that same period of time. So the link that exists between stock price performance and growth and value was what supported the performance even with that sharp decline. But at this time, the business was trading at two-and-ahalf times EBITDA.
Along came Hicks Muse, a leveraged buyout firm, and figured out that at 54 pounds or roughly 8 times EBITDA plus all that cash on the balance sheet, they could probably acquire the business. And they did, so that was the end of the public market investment in Weetabix. Now, this is a family-controlled company. And one of the pitfalls you face in investing in any family-controlled company is that they may not look at the capital structure with as much thought as you might. So in this case, even when they had a hundred million pounds of cash, I couldn't encourage them to buy back stock. So they had 11.8 million shares outstanding at the beginning and all the way through to the end. The good news was they weren't diluting our investment by offering 2 or 3 percent of the stock to management through options every year. But the bad news is that they didn't take advantage of what would have been a home run by taking out of the market shares at a price that reflected the market's focus on more sexy Internet company shares and its paranoia over Weetabix poor short term results.
Had they started buying back shares at 20 pounds a share, they would have retired 5 million shares, which would have taken the final number down to 6 million something. And the price would have remained the same, eight times operating cash flow of roughly 63 million would have still been 500 million pounds, but it would have been on the basis of far fewer shares, and instead of paying us 54 pounds, it would have been something closer to 75 or 80.
It just would have been the mathematics of having taken shares off the market. It's sort of a hypothetical, because they couldn't have picked up as much stock as that, because I owned 17 percent of the company, so those shares were out and the family-owned stock. They wouldn't have been able to find a full 5 million shares to reclaim all their money, but they could have found some, and it would have made our investment, I think, pay off more forcefully at the time had they been able to do that.
QUESTION: Do you find any difference in the American subsidiaries of foreign companies taking suggestions from activist shareholders?
TOM RUSSO: I'd have to say yes, but I would find that I'm equally unable to persuade American companies to do that, as I am foreign companies.
But I would just jump forward to some of the observations what we'll end with by saying one of the things that's changing in international investing is the growth in renegade pools of activist capital. So I'm a believer in the management-friendly style of investing.
So with that as my mantra, I tend not to be a very effective activist. When the business is well run and when they're at least neutral with cash, we're not in trouble. Because in this case what they didn't do is something smart with the cash, but what they most importantly didn't do is blow the money.
Let me share with you another global value stock pick, the Dutch newspaper De Telegraaf.
There's another company I like to talk about, de Telegraaf, which is a Dutch newspaper -- which I've owned over the same period of time -- which started life with a lot of cash and a relatively low EBITDA.
At the time I started investing in them, they had a lot of cash on their balance sheet. It's a bit difficult to consider newspaper cash their own cash because they did have subscriptions prepaid that fall into this line called cash.
They were very liquid, in any case, and trading at a relatively low multiple of its EBITDA. They had 52 million shares outstanding to begin with, and fortunately still today they have 52 million shares outstanding. At some point with their cash and growth, it was two hundred and some million shares outstanding. I just couldn't pound on their heads enough to get them to take some of that cash and buy back stock. But instead, they made all sorts of bone-headed acquisitions because they thought that their mission was to build the business.
They started out with magazines in Sweden, then they bought another newspaper in Holland, and they spent a lot of money on a new plant. They effectively managed to squander the cash that they had generated through their core business, which was an attractive business.
They didn't buy back stock, and more detrimentally to the investor is that they wasted the money. Fortunately the business franchise has survived. I stayed with the investment. It was relatively lackluster, because during this period they were squandering our money. As I started all the way back in the mid-80s -- and I went to Europe in part because the U.S. market was consumed by leveraged buyouts, and the valuations in Europe were less full because the businesses like newspapers, capable of setting cash flows, were under recognized by the market (absent Buffett's lessons) and capital pools didn't flow and they didn't like leveraged buyouts.
Now you've got leveraged buyout pools throughout the world and Kohlberg Kravis Roberts & Co (commonly referred to as KKR) acquired a European television broadcaster recently called Scandinavian Broadcast Systems. And in the Dutch market, Telegraaf had a 27 percent stake in that business, so they now have converted their stake to a share of KKR’s private mortgage company.
That was the start of a good thing, because rather than owning just a piece of a stumbling Dutch broadcaster, we now have a share of an European-wide entity that has a proper capital structure, more leverage, that's run by the talented folks that KKR had brought in. I think we'll make a lot more money being a participant in a leveraged equity than we would have if I stayed as a minority holder in a Dutch only TV station. We received those shares, and that's a good development.
More importantly, in Holland, you had CSM and you had VNU and you had three other companies, which all had historically controlled boards and often had controlled family share holdings suffer at the foot of activist shareholders.
And the management finally went back to the control family and said, "If you don't wake up, you're going to be awakened by an activist pool which will come in, and they'll simply strip this business and take all the value of the stock that's massively under priced. You can do it or they'll come and do it for you."
It's only been just recently that the changed environment has come to impact our interests favorably. It was from two forces. The first force is the growth and leveraged buyout pools affecting European companies. So this family recently decided that they'd sell a non-strategic asset, a newspaper. Then another leveraged buyout pool of money came from England run by a former English newspaper leader named Montgomery, and they paid twelve and a half times EBITDA to buy a newspaper in Holland, and two hundred and some million euros in cash flowed into the company. It was at the time when we [Telegraaf] had a market capitalization of 900 million.
For one small paper, they were paid 200 million. And the family then agreed for the first time ever to deploy some of that cash to buy back stock. This was a dud. And it was a dud not because they issued a lot of stock through options, because they just -- they kept that flat, not because they couldn't generate cash, but because historically they just didn't think about share buy back as a use for cash, and they felt it sort of imperative to spend the money, and they spent it unwisely.
The future is better because I think they're under a much shorter leash, not because I police them through my entreaties (because they were deaf to my recommendations over all of those years) but because the market has finally gotten new factors for leveraged buyout of pools to purchase those businesses and the activist pools to frighten those managers.
Company Specific Investments
That really leaps me forward. I would say how I invested abroad -- I'll just race through a couple more points, and then I'll open it up for questions. Brown Forman led to James Burrows. James Burrows is in one group of investments as an American you might make, and those are what I call company specific investments. I'd say Telegraaf is company specific. Weetabix was in a sense company specific. One way you find out about those is do exactly what Berkshire's chairman said that he did when he invested in Korea. You get a country guide, which in a very simplified fashion describes what the companies are that are public in the market, and you just thumb through it and look at the numbers on a standardized format. You'll see interesting businesses that exist in just local markets.
I knew about Weetabix from my wife's tastes. But in France, there's a company called Talc de Luzinac which I owned at one point which was the largest talcum powder producer in the world, very specific, very local, public, and cheap at the time.
In Argentina, there is a brewery called Killman's. It was sort of a loose affiliate of Heineken and a family of great standing. Something I discovered just by thumbing through country guides.
Country Specific Investments
So anytime someone says to me, for example, “The Norwegian market collapse” I'll give a very brief look at this investment. These are countryspecific investments.
Let's take a look here. A colleague of mine went to Williams College with a Norwegian from a prominent family. In 1991 the Norwegian market collapsed. It collapsed because of the conflict in the Middle East. The Suez Canal was closed off for shipping; the petroleum shipping that took place there ceased.
The Norwegian economy is extremely leveraged to oil, mainly because of shipping. And all of the ships were owned by families privately through leveraged pools they call some kind of KF funds or something, and extraordinary leverage to generate tax deductions to sheltered income from the very high tax rates that the people in Norway face.
The moment one of these ships goes dry, it goes into dock and comes off service, they go bankrupt. Because they're so leveraged that if they're not engaged, they immediately go bankrupt. Note that in Norway, there's no personal bankruptcy. So once the ships started to fail to provide commerce, the clock immediately starts ticking because you had to fund those investments out of other holdings. That process led to a collapse of the Norwegian stock market and was directly related to the Gulf War. So you said, "Norway's collapsed. What should we do?" My answer is, "Let's buy the newspaper." So I went over, and this one here was the Wall Street Journal of Norway, and a complete free fall. And this is 1991--$21 a share.
With global value investing you need to decide if you are going to hedge currency
A very interesting observation about this particular investment: One of the things that you either decide to do or not is hedge currency. And since I said at the start that I was sort of interested in providing some currency exposure through investing abroad, I'm clearly not presenting myself as fully hedged. Some people do. Some people have a practice that the only thing they are interested in is businesses abroad. They say, “We don't care about currency, we hedge every single investment. In this case, you couldn't have made that investment because the market was in such a free fall in Norway that there was no foreign market for hedging the currency. The interest rate differential was just so great that it wasn't practical to hedge.
Going into the investment that we made in Norway at that time, we knew that, and we knew we'd lose a lot of money to the currency because the market was not clearing, the pressures were that the crown would collapse; you couldn't hedge it.
But the investment was priced accordingly, because the same factors that led to the inability to hedge the currency were extremely high interest rates, but they also led to extremely low equity valuations.
We bought the shares and immediately suffered substantial currency declines. But over time, the discount in the valuation of the business, this regular business of the local Norwegian Wall Street Journal was sufficient to offset the currency, in fact. The result was sort of a seven-bagger over approximately fifteen years. It's probably a modest, not outrageous compound, but it was an example of yet again the first class of investments which are country specific.
You can't imagine anybody thinking about an investment that's less interesting than a Norwegian newspaper with 3.7 million potential readers in the world and no prospects for global growth. But that said, you can find very attractive businesses by thumbing through country guides and looking at just the specific investments within a given country.
Another area that I've used as an area of focus would be what I call the global brand leaders.
And those are pretty obvious. That's Nestlé, Heineken, Unilever, Cadbury Schweppes. If you're looking to get brands that are entrenched, that are legacy, there's really no better way to do it than someone like Heineken which has been in emerging markets for 35 years, or Nestlé that have had plants around the world for a hundred years.
Even Unilever and Cadbury have followed the British Empire around the world. They have terrific legacy brand value, and I own all of those with the idea that those branded positions enjoy sort of consumers in reserve. Because all the people who are aware of those brands during the periods of time when it had very little income, very little spendable money, discretionary spending, coveted those brands but couldn't afford them.
As the economies in India, China and the rest the world begin to prosper and discretionary spending goes up, some of the earliest luxuries that a consumer can afford are those brands that they couldn't afford before.
Global brand leaders are pretty apparent.
The third area that has been very helpful for me has been subsidiaries of global brand leaders
I look down the list of some of my investments over time, Allied Domecq, which was originally called Allied Lions, had an Irish tea company called Lion's Irish Tea, and they had a British -- I'm sorry -- a Canadian liquor company called Corby Distillers.
Now, both of those businesses were public in their home markets. Even though they were controlled by Allied Lions, they were public in their home markets because of something called the Foreign Investment Requirement Acts that exist in so many countries.
If you want to participate in a country as a foreign company, you were often required to leave a public stake outstanding in that market so that the locals wouldn't feel like they were being colonized. Those shares are issued under something like the Foreign Investment Requirement Act, maintaining a local presence. But there's no requirement that those shares have to be owned by local investors.
So I have again and again and again participated in markets in businesses that I like, cashgenerated businesses that are run by the global leaders with western tax treatments, western managers, and western style accounting. That way I'm able to participate in a market like -- well, neither Ireland or Canada concerned me -- but in other markets such as the Czech Republic, which I visited in the early '90s.
Now, while I came away with an investment in Philip Morris' Czech subsidiary, I couldn't in good conscience invest in almost all the other businesses I saw there because of the fear over the market, the rule of law of corporate governance. The former Communists who ran all the businesses, they just didn't impress me as the type of people I'd like to give my wallet to and ask them to give it back sometime later with more money in it. It just didn't impress me as such.
But I chose to participate in a market that I was sure would grow, which was the Czech market, because they have such a history of success in business, through a company such as Philip Morris Czech Republic. Now, this investment hasn't had the same appreciation over the years as has Philip Morris, its parent company. It's worth noting that one of the drawbacks of investing in the single market subsidiary of a global enterprise is that things happen. Indeed, the Czech market has increased disposable spending, and so the share of the Czech market of local products that Philip Morris still produces has gone down as their international brands have gone up and had higher prices and higher margins. So that has played out. But other things have conspired to dim the returns offered by this investment.
One of them is that as a part of the Altria universe, when Altria [parent company of Philip Morris] wants to list company's dividends and this company is not allowed to reinvest their Czech market cash flows into Uzbekistan or into the markets that are growing outside of Czechoslovakia in the same region. Even though we have knowledge of the markets, Altria retains the ability to invest directly in those markets. The Czech subsidiaries are Czech only.
As a result, when they develop abundant cash flow, in order to get at that money, the parent has to dividend it out. And they get an 85 percent tax exclusion on that dividend, but we'd have to take the dividend. So over the years, this business has paid out dividend incomes that have averaged over 13 percent.
At the moment, the dividend is still 9 percent. I'd much rather as an investor not have taxable income, and I would much rather they took every dollar of free cash and bought back the shares or done something to increase the compound. We had an extraordinary dividend deal from that investment all along, but we hadn't been able to re-employ the capital into growing into other markets that were adjacent, and we paid a lot of taxes unnecessarily. So that's one of the pitfalls.
The other thing that's interesting about the third area that I have participated in, which is this global leaders local market subsidiaries, is you can become a pawn in a couple of factors. One factor is that Altria originally used the facilities in the Czech Republic to produce for the Russian market. They would ship across the border to Russia.
At some point, they proved up the market and the Russian market built a facility that they then needed to shift the production to. We lost absorption. Russia developed its own product and therefore the Czech market suffered. That's one aspect, the other is the global battlefield can sell on you for reasons that are non-Czech. So for example, if Altria goes into Italy in a way that upsets its competitor British American Tobacco [BAT], BAT may respond in a disruptive way to the Czech market that our company has to respond to at the expense of earnings that are specific to this market.
Over the years I've invested in several global markets. One of them was in the Irish market, and it was called Readymix PLC, which was a construction equipment and crushed stone company. And it worked fine. I've owned Readymix since the early '90s. It paid a little dividend, it's grown well, and yet it's just exactly what I was referring to before, it couldn't grow with other markets and it's Global value investing, in general, is an interesting way to invest, but it does come with some pitfalls. very controlled because the parent of Redi-Mix Corp controlled the rest of the market that they otherwise might have coveted because of adjacencies.
I visited with Readymix in the early 1990s. It was very, very cheap, but it was controlled by a foreign company. I was comfortable that it wouldn't have local market issues. But its counterpart, CRH, the international building materials group, has been an absolute growth engine, and it's grown well beyond the Irish market, because it's Irish based, and they looked upon the rest of the world as their oyster. I'd have been far better off in that particular instance buying CRH at a roughly equivalent value but the allowing the compound of that reinvestment to move us farther along as they built a global empire.
Readymix has just sort of stagnated in its local market. It was statistically cheaper than CRH, but it hasn't had the same growth because dividends were paid out and its marketing opportunities were constrained by the local market.
Then you can try to be a little too clever
For all of these years, I tried to find local subsidiary ways to play the great global leaders. Every time I met with Coca-Cola in the early 1980s, I'd say, "Well, tell me about the markets. You have local subsidiaries, tell me about the markets." And, of course, Coke just soared during this period. I was in search of the perfect small market play on Coke. I'd have been far better off at that point just buying the global leaders.
The last point I’d state is that if you want to be a global investor, there’s absolutely no reason why you’d ignore American companies whose greatest prospects are foreign. So in this portfolio, I would include among them Brown Forman [nyse:BFB]. I initially invested in Brown Forman, a wine and spirits company, back in 1986 time frame when it collapsed and led me to James Burrows, and I invested then. In 1986, Brown Forman may have done 4 million cases a year of Jack Daniel’s, 3.5 million of which were U.S. They're now up over 7 million, and the additional three and a half million cases have all come from foreign markets. It's all come at much higher margins than the U.S. markets.
Throughout this period of time, Brown Forman has been willing to sacrifice near-term earnings to invest in the startup of those international markets. So investing in Brown Forman in the U.S. with U.S. law, and I know the people, I know where they went to school, I know what their values are, I'm still able to capture enormous global growth.
So I would say it certainly is the case with Brown Forman. And in their case, one of the reasons the investment has performed as well as it has is even though it's family controlled, they understand what it means to buy back stock. Over this period of time, there have been three periods when they bought back 15 percent of the shares when they were mispriced by the market. As a result, the remaining shares enjoyed a leveraged return, the last time about three years ago with interest rates at three and a half percent, to buy back several hundred million dollars worth of stock. Only now, just as an aside, have the European companies begun to consider share buy back as a promising possibility.
They used these very cheap borrowed funds to buy back an under-priced share. And so that fiscal or corporate finance sophistication helped us in the investment where we never really had similar help from our foreign holdings. Another pitfall that I'll refer to is a fairly arcane and specific one but it's an intriguing one. I own shares of Heineken's holding company. Heineken's holding company is specifically tied to Heineken NV.
Heineken NV is an index listed and fairly liquid member of the Dutch index. At some point, the holding company shares – which have a one-forone relationship, which means for every holding company share, you have one share of NV -- the holding company shares have always traded at a modest discount because they're less liquid, they're controlled by the family, people worry that the family will steal from you somehow. About four years ago, following the creation of the European Union [EU], the pension assets in Holland were permitted for the first time ever to invest EU wide. What it meant was that the EU exposure that the Dutch pension funds wished to gain would come from indexing the largest German companies, the largest Spanish companies, and the largest Italian companies. For a time before then, the Dutch pooled their own Dutch stocks because they were required to own Dutch stocks in the pension funds. If they were stockholders, they had to be Dutch stockholders. So a portion of that money finally spilled down to Heineken Holding, which is less liquid and not part of the index.
Once released and the capital re-allocated, there was selling in the Dutch market of Heineken Holdings to free up that capital to go into the German index, the Spanish index and the Italian index. Therefore the Italians, Germans and Spanish came in and bought the Dutch index, which led the share price of those members of the Dutch index higher, while at the same time Dutch selling drove the share price of the holding company in Heineken lower. For a period of several years, the spread that had historically been 10 or 15 percent widened to as much as 40 percent.
Now, I'm a shareholder in Heineken Holdings. I look at that as opportunity to buy more Heineken Holding shares. But the pressure was for factors that relate to the macro world.
And you'll see time and again as you invest abroad that there will be macro factors
A couple of those over the time that have helped boost my investment returns. Another was the world health scare of SARS and the Asian based avian flu and their impact on China and Asia-related investments.
As Asian stocks declined because of the fear that China would become insular and set back, we were able, based on substantial investments in Richemont – the Swiss based luxury goods company, whose business suffered during the avian flu and SARS epidemic -- and we took advantage of what was a crisis at the time. At the same time, Altria, my largest holding, sent the chairman over to China at the time when most of the world sort of avoided China. He came over and said, "We're with you through thick and thin."
The Chinese government appreciated that expression of support, and some years later gave Altria the only contract, legal contract, to develop a manufacturing presence in China and to develop a relationship with the Chinese monopoly to sell Chinese brands abroad. The opportunity to strike during a period of crisis definitely exists, and that was an example.
Let me share with you some of the pitfalls of global value investing
One major pitfall is language and culture. Very close colleagues of mine took me to Korea after the '98 currency crises. The Asian markets suffered from too much capital flows, over building and then the collapse of their currencies.
In the midst of that, we went to Korea. And, you know, I was extraordinarily frustrated because I was literally at the mercy of the interpreters, which is yet another pitfall. I very much tried my best to understand the specific factors of which I made an investment and went to the Lotte Confectionery Company, which is just what I wanted, it's a confection company in a decent market.
We sat with the vice chairman and spoke for almost 45 minutes. I asked a question about the following year's cash flow. The interpreter and the vice chairman spoke for about 45 minutes, at which point the interpreter said to me, "Better." I sort of threw up my hands. Because all of that dialogue, I didn't know if they were talking about their golf game or what they were doing. But if in talking they were talking about the ingredients that supported the conclusion "better," what I heard back was "better," and that wasn't enough. As a result, I was somewhat dismayed by the culture and the language.
I remember at the time, there was also a great bankruptcy that occurred with a company called Hinix, and there was a photograph of the chairman being led off in chains, and he had a terrific suit on, he had a heavy, blue, full-length cashmere winter coat, and then sort of below his knees he had this pair of high-top Reeboks with, you know, all of these vibrant stripes and everything else.
Looking at that photo I realized that I just don't understand a country and a culture where they can be all dressed above their knees and then down below, you know, in public in a professional setting wear high-top Reeboks. I couldn't quite get my arms around a culture that would have such contrasts apparent. But those things led me astray, because the market is up probably twelve-fold since '98 when I passed for cultural reasons. So I just think you have to be awfully careful when investing outside your own country, language and culture.
Let me take a few moments to share my thoughts on some interesting current issues – one being corporate governance standards
Americans are trying to hoist the Europeans with our corporate governance sort of trends. I own a large position in Nestlé, and Nestlé's CEO was nominated by its board to replace the chairman a year and a half ago, for reasons that are quite specific. The board had a recent expansion with many, many young and recent tenured board members, and the board felt that with lacking experience, they wanted to have the CEO who was a board member appointed as chair to see them through the period of time.
At the same time in the executive committee, there were also a whole series of changes. That meant as a CEO, he felt uncomfortable relinquishing the title. There were enormous amounts of business integration, global management change, and he felt uncomfortable giving up those responsibilities at a time when his executive committee at that particular time was a very young tenure. Rather begrudgingly he accepted the joint position with the condition that it would be temporary.
In the USA, Institutional Shareholder Services [ISS], providers of proxy voting and corporate governance services to institutional investors, and others in North America mounted a charge against Nestlé because that was going towards the American model that they resist and away from the European model of non-exec chair.
The American investors of Nestlé began to speak, uniformly agreed with Nestlé that they were comfortable with the reasons that the chairman and CEO would rest temporarily in this one person, in particular because this person happens to be extraordinary. Nestlé's history over 80 years is that they only had a joint position like this I think less than 12 years out of 85 or something. It's quoted on the history and the pattern of conduct.
The American shareholders, who all agreed with Nestlé at the same time, then said that they would vote against it, because as long as the proxy consultants in North America said it was against corporate governance best practices, they felt as money managers unwilling to go against that, because it shows in order to take a stand contrary to an ISS or someone like ISS's perspective, you have to have such paperwork to comply to meet the standards of disagreeing. It's a hurdle that no one was willing to take, even though in conversations with management, they concurred with the wisdom of that way.
That shows you there's a growing reach of corporate governance that not necessarily will lead to better outcomes
Heineken had the same thing happen. I've talked about the Heineken Holding Company versus the Heineken NV. The holding company, family controlled, controls the NV, and has given the NV the patience to invest for the long haul, the patience to take investments that don't pay off soon but will pay off not short-term rich but long-term rich, and Heineken has succeeded over the years by having that stable capital structure. A western shareholder tried to dislodge that by insisting that they collapse that structure. I believe it's added value not detracted value. But the world of corporate governance is converging around the international holdings. The good news on share re-purchase is that it's become much more frequently used abroad.
For example, Nestlé announced a $5 billion share re-purchase in the last year, having never had one before, and it reflects their view that the opportunity is compelling in light of the market's undervaluation.
On another front, the stock option successes in the U.S haven't surfaced internationally. As I said at the start, I felt that they've been more patient as executives in looking out. But the stock option abuse could lead to more short-term conduct. It really hasn't kicked in. The rising pools of activist capital have helped me in Telegraaf, and the appearance of the leverage buyer capital helped Weetabix. It hasn't helped; it took away Weetabix, to be specific. But the valuation level in general goes up because there are pools of capital willing to commit to privatize businesses when they're out of favor.
Many of my investments sell consumer products, and as a result they are increasingly selling through ever larger global retailers. So as a phenomenon, I worry about pricing pressure and the inability for my manufacturers to appeal to their consumers through an increasingly consolidated retailers environment, which increasingly has power to threaten to delist their products from their shelves if they don't agree to tougher terms. So that's a world that I inhabit and another pitfall.
One last thing I'd say before your questions, is, the threat of counterfeit. Since I invest in the world of intellectual property, brands, trademarks, is something that's very timely. It's a critical issue as time goes forward. And, as I described at the start, global investing is 40 percent of my day. So I've given you a sense of how I spend 40 percent of my time and what I care about and how I've gotten there.
That concludes my prepared remarks about Global Value Investing, now I will be happy to answer any of your questions.
QUESTION: Coming back to your Weetabix example, how high will you go with one stock as a percentage of your portfolio? When the price rose and your percentage of ownership increased and your margin of safety reduced, were you tempted to sell or reduce?
TOM RUSSO: I'm comfortable with positions as large as 10 percent. I won't typically go much beyond 10 percent, which reflects my lawyerly ways.
I believe that I can know what's important operationally for most companies, but I can't ever really know about the thing that is most important, which is litigation risk. So I stop around 10 percent.
Weetabix never got near 10 percent at market value. It ended up being 10 percent on take out, but it was never really that large of a position that I had to re-weight it. It was because at the start -- when you think about it, it was only 11 million shares times 5 pounds, it was a 60 million market cap when it started, got to something like 500 million at one point. The good news at the start is I had very little money demands, and so I could take advantage of it. At the end, every share I bought could find a home without worrying about weighting. So as far as the movement towards intrinsic value, I always felt that 8 times was too low, because most food company acquisitions have come at something north of 10. So 8 was conservative because I just never knew what the family might do. You know, the risk is that they can also disabuse your interest when they sell the business.
When this company was sold the chairman and the CEO stayed on to work with the leveraged buyout firm. My risk at that point was that I had no idea of the term structure of the compensation deal that Hicks Muse entered into with the family member who sold out his family, colleagues, as well as the public shareholders. So the risk of that occurring kept the multiple below what a public company typically sold for. So it never (at 8 times earnings) got close enough for me to feel the pressure. It was still trading at a 25 percent discount to intrinsic value. That's when I ended up with 16 or 17 percent of the shares outstanding and I just kept buying. It was hard because the clients, as I said, hated the products, and they didn't like to see the collapse that happened to occur at the same time when so much easy money was being made with Internet stocks.
It was one of those great moments where Weetabix would go down weekly and Cisco would quadruple daily. It doesn't get much worse than that.
QUESTION: What is your opinion of Budweiser [BUD]?
TOM RUSSO: It's more expensive than the companies that I have invested in the beer business, which is Heineken, and we own SAB Miller through Altria. I don't know what it is; it's $7 billion in SAB Miller through Altria. With Budweiser, I've been really impressed with their ability to create demand for their product abroad. Particularly in China, the BUD brand itself is developing a following, the Chinese like it. The market doesn't have enough margin yet to make any difference because the pricing is so low.
But the brand is there, and I think it's going to be a good factor going forward. I think you can -- if you just adopt a very long horizon, you probably would do well with Budweiser. But it just seems expensive in terms of the valuation.
The other thing is a bit surprising - it's not a family-controlled company. The Busch family, though in secure control of the business, really only own about one percent of the company. BUD is a bit quirky, and there's just some weird stuff. There's some weird family dynamics at Budweiser right now, Pat Stokes versus the young August. There's weird stuff, and that fight hasn't been fully fought.
QUESTION: What are your thoughts on the valuation of Berkshire Hathaway?
TOM RUSSO: Well, I think this week was an encouraging visit with management. I think what they've done is a couple of things. Warren Buffett and the Berkshire board of directors have wrestled with succession. And one way of getting that done is that they've communicated with the managers who run the subsidiaries personally through visits to the board, what it means to be part of Berkshire.
Berkshire’s culture comes back in a simple message, maintain and extend your competitive advantage or moat. We have more money than you'll need ever. But everything you want to do, come tell us, and if it's good, you'll do it because we want you to deepen and broaden your moat. Most importantly, at Berkshire the message is never do anything with our reputation, period, full stop.
Berkshire’s message of its culture has become far more prominently delivered. It certainly was so at the annual meeting. Shareholders’ concern then about succession, how would the firm succeed more and succeed after Warren I think is answered by the fact that the culture is now more front and center discussed and probably sustainable. It has to be so if, for instance, recently acquired, Iscar Manufacturing was willing to keep 20 percent of their business with the partner at Berkshire. If they felt that Berkshire was going to change course in midstream, they just committed corporate suicide if it were in fact that the business was going to be run differently with different values going forward.
The Iscar acquisition sent a big message that the values will remain. And so the fear over succession, I think, has been addressed, and I think that's been a weight on the stock price. Also the fear over what they can do with the capital has been addressed because they've just committed about $18 billion in acquisitions over the last 24 months.
Well I see that my time is up and I will be happy to stay after the break to meet each of you and answer any other questions that you may have. Thank you.
