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Inoculated Investor
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In Annual Meeting, Markel and Gayer Discuss: Brookfield Asset Management, Fannie Mae, Freddie Mac, Berkshire Hathaway, AIG, General Electric, and Diageo

Markel Corp Annual Meeting Notes

Disclaimer: These notes were taken in real time at the Markel (NYSE:MKL) Annual Meeting in Omaha, Nebraska on Sunday May 2 nd, 2009 without the use of a recorder. The goal was to get the gist of the questions and as much of the answer as possible. Please excuse any mistakes or omissions.

A. Introductory Remarks

EVP/CIO Tom Gayner: MKL has focused on liquidity over the last few years and has kept a lot of cash on hand. This is what they have been doing with shareholder money recently. Gayner mentioned the question that Buffett brought up at the Berkshire (BRK) annual meeting the day before: What would he and Steve Markel do differently if MKL was a private company? There should never be an actual answer to this question. The answer should be nothing. Businesses should not be run any other way

MKL likes companies that have survivability, companies that are ready, willing and able to answer the bell for the next round, want companies that in 20 years you will still be talking about. The example he brought up was Marriot (MAR)

CEO Steve Markel 2008 was not an easy year to assess. They need more time to properly assess the full impact and results of 2008. Looking back at it, 2008 was an historic year. They are happy with themselves on a relative basis. But, they prefer to have done better. In any case they are extremely optimistic about the long-term future of MKL. Believe that we all need to look at MKL and all companies with a long term time horizon. They understand that the current crisis will lead to many changes in the world but they feel MKL is ready to adapt as needed

Long term values are very important. Companies have to build a set of lasting principles to operate under. More importantly companies have to stick with these principles regardless of the operating environment. Throughout the organization they have identified core principles and have stuck to them. In areas in which they felt they had issues they have re-examined their processes and made the necessary changes

B. Q&A Section

Question 1: ( David Winters , The Wintergreen Fund) Are AIG (NYSE:AIG) and its current practices hurting the industry as a whole?

Markel: Yes, a little bit. But not as badly as some people have been suggesting. Clients of AIG are asking a lot of questions and there is extreme disruption in the market. AIG is cutting the heart out of some of their policies, especially upon renewals so that they can keep the business. About 5% of the time Markel’s estimate) AIG is doing very stupid things when it comes to renewals. The bigger problem is that the competitors are using AIG’s problems and lack of pricing discipline not to raise their own prices. This is solely Markel’s opinion but he believes that the insurance companies are going to have to reinvigorate and re-discipline their troops. There is a lot of resistance to price increases (partially as a result of AIG). Q1 2008-Q3 2008: MKL’s renewals were 5-7% below previous rates. Q4 2008: Renewals were only 1-2% below previous rates as they started pushing through price increases in Q4. Takes some time to get the price increases through. Q1 2009 should actually have a positive pricing impact based on some non-renewals and some price increases

Question 2: What business lines are the toughest to pass through increases?

Markel: :

: Oil rigs on the Gulf Coast, hurricane property and casualty, umbrella policies, European policies

Tough: Excess/surplus liability, commercial contractors, California earthquake

Question 3: How is the One [b]Markel: Program progressing?[/b]

Markel: MKL used to be segregated by products with certain specialists located in specific offices around the country. Felt that they were missing opportunities to cross sell and were not serving clients well enough. Clients did not even know about other products MKL was offering. Now have moved to 5 regional offices where they have experts in each office. This has turned the organization sideways. Started in 2008 in Dallas and now have rolled it out countrywide. Things are going well despite a little noise and little chaos

Question 4: Can you discuss the investment case for Brookfield Asset Mgmt (NYSE:BAM)?

Gayner: MKL has a long term relationship with BAM. CFO’s mother used to work at MKL. BAM has made some tremendous capital allocation decisions. Natural resources: timber, paper mills, hydroelectric dams. Have realized that the forest is a better investment than the mill. Try to buy minimal capital expenditure requiring assets that will go up in value over time. Thus they own better assets over time. Like and trust the people who run BAM. Believe it is priced attractively and expect to own it for the long run. Will protect against inflation due to the hard asset focus

Question 5: Can you discuss the Fannie Mae (FNM) and Freddie Mac (FRE) positions?

Gayner: They own senior debt as well as some preferred stock. Believe that they are both permanently impaired. In the future would like to have as little FRE/FNM exposure as possible

Question 6: Are there conditions for economic expansion out there right now?

Gayner: Every business is making decisions faster and sorting things out faster. Can’t put off hard decisions any longer. Net effect of this rationalization creates the seeds of growth. Feels like the 1970’s to them when there were a number of great companies created. Entrepreneurialism was rampant then because it had to be. This is the case now

Question 7: What inning are we in when it comes to this rationalization? Are the changes permanent?

Gayner: Quoting Jeremy Grantham he indicated that over cycles we learn nothing. Only short term lessons stick in people’s minds. In the long term we make the same mistakes over and over. Business is cyclical and circular so the changes are not likely to be permanent. Felt that we still had a ways to go in this rationalization

Question 8: What lessons were learned in 2008?

Gayner: Leverage is a killer, Even if you are fundamentally right you may not be able to play out your hand due to leverage. This includes explicit and implicit leverage. Collateral/contagion damage from the macro level can be just as devastating as on balance sheet leverage. Being levered to the system is dangerous also. Don’t learn the wrong lesson. It’s easy to make generalizations about this period that will be harmful for the future and may not even be accurate. 2008 was a real rattlesnake. But in the future you have to be able to discern between the real snakes and the fake snakes. You can’t operate as if you are constantly afraid of finding snakes. Have to be able to dust yourself off and get back in the ring. Believe their skill levels are higher after going through such a tough period

Question 9: In the new One Markel model, who has the underwriting pen?

Markel: Underwriting profit is the absolute most important thing for MKL as a company. They are taking experts from specialist areas and are deploying them around the country in the 5 regional offices to make sure there are experienced people writing policies. They are also putting in new technology systems that will help them monitor underwriting

Question 10: Can you discuss the future premium growth rate for MKL?

Markel: MKL is a much larger company than previous but the company’s growth rate has been much higher than the industry as a whole. In the past 20 years they have been growing faster than GDP. In 2008 they had $2B in premiums written on $2B in equity. In 1986 they had $50M in premiums written on $25M in equity. 20% growth they have seen is not sustainable over time. Now they have about $1.4B in US premiums and $600M outside the US. In 2009 they expect the full P&C market to be about $450B so their $1.4B is still a very small piece of the pie. Think there is a very long runway in front of them. Think there is a huge opportunity to grow through organic growth and acquisitions. Will be launching new products as well

Gayner: Have managed to gain scale by finding experts that could grow the MKL web in a silo-ed fashion. They are now better able to leverage expert talent through technology

Markel: One also leads to better scale. Believe that they have a lot of room to grow outside of the US as only 33% of their business is overseas. World will continue to develop and grow. People have tasted wealth and are not willing to give it up. This is actually going to be the stronger side of the business in the future. MKL is agnostic between using capital to write premiums or using it for investment purposes. They are now looking to purchase wholly owned subsidiaries like BRK does. They have their flag up looking for companies that would like to be under the MKL umbrella as the leveraged private equity model has not worked out so well

Question 11: What was their take on the Berkshire Hathaway (BRK-A) (BRK-B) Annual Meeting?

Gayner: They didn’t learn anything new per se. But that is a good thing. It shows that the value investing principles are timeless. Don’t need to learn new things when it comes to the discipline required to run businesses. The BRK annual meeting is kind of like going to church. You don’t learn new things each week. You haven’t forgotten the principles. You go to get filled up or re-filled by Buffett and Munger

Question 12: Is specialty insurance a sustainable business?

Gayner: Yes, because it solves unique problems. For example data breach security. This is something that 20 years ago no one was talking about. New problems emerge and new products will be necessary

Markel: Insurance industry has survivability. The need to transfer/share risk is always there. What makes a singular company survivable? Most people would not have pegged AIG as a potential casualty 1975: most insurance companies have gone bankrupt since then. High casualty rate. Culture, business principles, doing the right thing will help you last. MKL still young and small relatively. Want to be around at least 100 years

Question 13: Tom Russo (Gardner, Russo & Gardner) – Why would someone not want to buy pieces of AIG at distressed prices?

There is definitely interest out there. AIG recently sold Hartford Steam Boiler for about $1B after recently being bought for about $2B. AIG was looking for cash purchasers with the ability to write a $1B check. People did not think MKL could write that check even though they were very interested. Apparently the balance sheet for Hartford Steam was not as clean as people had thought and that led to the discounted price

Question 14: How is Terra Nova Insurance in London doing in terms of expanding throughout the rest of the world?

Markel: Like Buffett has done with General Re, MKL has done a post mortem on the Terra Nova deal In March 2000 they bought a damaged company for what they thought was a fair price. In retrospect they paid too much because the problems were greater than they anticipated. In 2000 they had about $1B in premiums and that has been reduced to $400-$500M recently. Did this on purpose to rationalize the book. Getting it back up towards $600M as growth opportunities continue to present themselves.

Did a One Markel –like reorganization with the international division and eliminated rampant cross subsidiary competition. Now have had 3-4 consecutive years of underwriting profit. Division is now providing a good float. Focusing on generating returns for shareholders has now become part of the culture internationally. They came in an infused the MKL culture and it has really been beneficial

Gayner: When people and nervous employees ask them if they have any experience with a transformation like Markel. One they say yes. Look at MKL international

Question 15: What are the private equity options looking like right now?

Gayner: They started looking like 3-4 years ago. Thought the leveraged private equity model was flawed and would not last. Were a bit early on that call but since then it has cracked. As a result of the previous strength of the leveraged PE model they were only able to buy large, but non-controlling stakes in firms. They learned that they were not good non-controlling shareholder. Believe that they are control freaks. As a result they have done recent deals in which they bought 80% of the equity

Example: AMF Equipment Machinery. This is a company that supplies baking machines. Will have $100M in revenues in 2009. They are very happy with this deal. This is a crawl, walk then run process. Going to take it slow.

Ideal deal right now a is $5-$25M transaction. Will grow over time. Same deals as Buffett with fewer zeros

Question 16: You talked about GE as a good long last year. What happened?

Gayner: This was a hidden leverage problem. Steve Markel was suspicious of GE and Gayner wishes he had listened to Markel. GE has been at the epicenter of the storm. They liked the idea that Welch was out and Immelt was not in the habit of smoothing out earnings. Knew that Welch manipulated earnings by looking at their insurance operations. Thought that Immelt has done a good job de-emphasizing that. It looked like a classic good value play. But the events of 2008 have made Immelt’s course much more difficult now. Think that the positives are still there. Right now there is a different between the company and the stock price. Price is guaranteed to be wrong. However, this is a bit of a bi-modal outcome. Either the stock goes to $0 or $60-$75. Would not have chosen this fight if they had known in advance. They will avoid these types of situations in the future

Markel: Was suspicious of Jack Welch. Was not his favorite leader. Too much leverage in the insurance business worried him. But the core GE stuff such as power generation is still good. Operating within MKL’s core competency has been re-emphasized. If they had known it was going to be this complicated they would never have gotten in

Question 17: Marcelo Lima- Why not buy LEAPs on GE due to the bi-modal outcomes?

Gayner: At $8-$12 a share GE is a LEAP. A leap of faith more like. Right now meat and potato companies can be bought at prices we have not seen in years. You can build 70-80% of your portfolio with these solid companies. The rest of the portfolio you use to buy leaps like GE

Question 18: Please comment on your policy on loss reserves and give us an idea of your current liquidity situation in the case of a large catastrophe?

Markel: (2 nd part first): Large part of the investment portfolio ($1.1B) could be liquidated if a large catastrophe loss occurred. Their exposure to any catastrophe loss is well below this figure. Getting reserves right is critical. Can’t price for tomorrow if you don’t estimate your needed reserves right. You can be either too conservative or too optimistic. They like to pick a number that it way more likely to be redundant than deficient. Don’t want a midpoint number, they want a margin of safety. Leads to a conservative view on pricing as well. Leads to a focus on long term investments. Need solid, secure fixed income investments to protect against loss reserve deficits. Industry as a whole has been bleeding loss reserves down. Current book has a combined ratio above 100%. Many companies are benefitting from previous redundancies that bring the aggregate combined ratio below 100%. Not true at MKL since they are always conservative

Question 19: Why is MKL holding so much cash?

Gayner: They are concerned about inflation. Don’t know when it will come. Carrying more short term securities than before. Expecting an interest rate spike. Does not want to own long term bonds. “Last thing we want to own..”. Want to own businesses with pricing power. Not earning much on their cash but they want to preserve the option that comes with holding cash

Question 20: What is the thesis on Diageo?

Gayner: It fits the 4 criteria they look for: Profitable business with a high return on capital, Return on total capital is their preferred metric; Run by honest, talented people (weigh those traits 50-50); Has positive re-investment dynamics; Earns a high ROC and can re-invest at that rate; If they can’t re-invest at that rate then they pay dividends and buy back shares; Priced fairly. Look for businesses in which 5-10 year shareholder returns mirror the returns provided by the business. All comes down to what you have to pay

Question 21: What is the impact of government actions going to be on the financial industry?

Gayner: Gov’t is a bigger part of business than before. He is worried about gov’t action. You can connect the dots between the growth of FNM and FRE and the recent turmoil in the mortgage industry. Gov’t involvement pushes away private business people. They now ask the constant question: How could the gov’t screw this business/industry up? They missed medical company opportunities over the last few years as a result of this fear. The whole world is now a bank stock. Nothing works without the banking industry. Problems will eventually get solved but it will take time

Inoculated Investor


About the author:

Inoculated Investor

My name is Ben C. and I am 2nd year MBA candidate at the Anderson School of Business at the University of California- Los Angeles. I have a BS in Economics from the Wharton School of Business at the University of Pennsylvania. Before coming to Anderson I worked as a generalist equity research analyst for Right Wall Capital, a long-short equity hedge fund located in New York City. Prior to working at Right Wall I worked as an analyst at Blue Ram Capital, another long-short equity hedge fund located in Rye Brook, NY. This past summer, I worked for West Coast Asset Management as a research analyst. West Coast, which was co-founded by Kinko’s founder Paul Orfalea, is run by well-known value investors Lance Helfert and Atticus Lowe.

Rating: 4.3/5 (23 votes)


Vgm - 8 years ago    Report SPAM

Thanks a million (or should it be a billion?!) for sharing your notes from BRK, LUK and MKL meetings. Extremely useful. Extremely generous.


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