After his lecture at the Fall 2020 Value Investing Course at Peking University's Guanghua School of Management, Mohnish Pabrai took questions from the students and sit-in audience members. The topics were very interesting to both the students and the professionals who sat in for the lecture. Below are some of the most fascinating questions and answers that I want to highlight.
Question 1: You mentioned that by looking at the history, one can find clues about whether a company has the DNA of spawning. According to your experiences, how long on average it takes to discover that a company at this early stage has this kind of DNA?
According to Pabrai, this varies by company. Some of these companies were founded more than two decades years ago. The best ones are the ones where it's very obvious that spawning is very core to their DNA. It doesn't need to be a 30-year old business. It can be obvious in 10 years. It can even be obvious in five years. You can see that relatively quickly.
Pabrai said he would only invest when it's very obvious that a company has great spawning DNA. Pabrai would also put an upper limit of the market cap at $50 billion. He referred to a quote in Upanishads which goes like this:
"As is your wish, so is your will. And as is your will, so is your desire. And as is your desire, so is your deed. Your deepest desire is your destiny."
So if you truly want something and you focus on it, it will happen. If you follow the criteria and systematically go through the list of stocks, you may only find one in a year, and that is enough. You don't need too many.
Question 2: What helps you identify a "Spawner" apart from their history? For example, is management an important factor that you look at? And if so, how do you identify good management?
You can tell the obvious ones, according to Pabria. For example, "Alphabet (GOOGL, Financial) has this thing in their financial reports called 'other bets.'" In the past, when Pabrai looked at Alphabet's other bets segment, he would just assign a value of zero because they were too embryonic. Now, Pabrai views Alphabet differently, and especially the other bets business, because Alphanet is a proven "Spawner." It has been proven that Alphabet has a spawning DNA to create new businesses. If you view Alphabet this way, you won't assign a value of zero to the other bets business and you can justify paying something for the segment, whether it's a few billion or more.
Question 3: What are common elements of "Spawners" in terms of management team or culture? And can you give us some example of fake "Spawners?"
Pabrai actually invested in a fake Spawner early in his career in the 1990s and made a lot of money out of it. He admitted it is true that it may be hard to tell which ones are a fake and which ones are not a fake. If you want to make sure that you avoid the fake ones, set a high bar. It has to be obvious.
The common element across all of the "Spawners" Pabrai has invested in is that there is a long history that he could study about the management. He could look at their behavior and what they've actually executed over a very long period of time. He could tell whether they have the "spawning" DNA. Generally speaking, he said you need at least 10 or 15 years of history on the management team, which can give you enough data.
Question 4: On a practical side, companies like Facebook (FB, Financial), Google,Tencent (TCEHY, Financial) or Alibaba (BABA, Financial), before they were $5 billion in market cap or even $10 billion in market cap, they were very small and single product businesses with very highly uncertain future. How do you reconcile this (early stage uncertainty) with a required long history of spawning if you say they are "Spawners?"
Pabrai said that while it is true that when Google came public they were a single product internet search company, they quickly dominated the search business with more than 90% of the market share. You could easily tell that their revenue potential just on the search business was huge. Thus, Google would have been a bet based on the potential of the search business. Back then, it would not have been a bet based on its spawning capabilities. But then, they started to spawn new businesses and you could tell that they have the created this "spawning" DNA.
Similarly, perhaps when Li Lu (Trades, Portfolio) first made his investment in BYD (HKSE:01211, Financial), BYD was not a "Spawner." But then BYD entered into the electric car business, which was completely new to it. Probably many were skeptical of that move, but the management team made it work. With the "Spawner" framework, when you see that happens, you know you can keep this business because now it has the "spawning" DNA.
Question 5: When you try to identify new "Spawners," are you concerned that the companies may get a little bit too excited in burning cash or get distracted on the way instead of excelling at the things they are truly good at? For example, if McDonald's tried to be a "Spawner" in the early days, is it possible that it may just not get to where it is at today?
One of the core DNA traits of a great "Spawner" is that they are not going to make large, early bets. In other words, they will be unwilling to bet the farm. For example, BYD's entry into the N95 masks business is completely new. But even if they completely failed in the masks business it would be a rounding error. In other words, the failure of the masks business (the new "spawn") wouldn't have much impact on bottom line.
Similarly, the bets Amazon (AMZN, Financial) makes are usually not very large bets compared to the rest of the business, but if they see there's something happening they'll put up more capital and increase their bets. And if it keeps moving along they'll increase their bet size again. However, the moment they start seeing that something is not working they will pull back the capital investment. For instance, when Amazon came out with their Fire smartphone, they were very excited about it, but when they saw there wasn't much traction, they moved on. The bet size relative to the mothership for a good "Spawner" is always going to be small. That's one of the things you can look for.
Spawning requires you to have an approach where you can excel in multiple areas but most businesses can' excel in multiple areas. They can only focus on one thing. Costco (COST, Financial) is the classic non-Spawner because they have one format and they've just stuck to that format forever, and they will not change. It has worked well for a long time.
Tesla (TSLA, Financial) is entirely different. Elon Musk could make a really large bet on something unproven. It is very different to the way Jeff Bezos and company would operate. It's better to watch out for that type of behavior.
Read more here:
- Mohnish Pabrai Shares Insights on Identifying 10 to 100-Baggers - Part 1
- Li Lu Explains the Case for China - Part 8
- Li Lu Explains the Case for China - Part 7
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