Dec 29, 2010
Assessing a Company’s Management
Cara Goldenberg of Permian Investment Partners is a young fund manager that has been making some waves. A while back she mailed Warren Buffett a few investment ideas and was invited to meet with him one on one. Recently, she was featured in Fortune, where she talked a lot about her firm’s emphasis on looking at the managers behind a business:
At just 30 years old, Cara Goldenberg is at the top of her game. She is the founder and managing partner of Permian Investment Partners, a New York City-based hedge fund she launched in 2008.
Goldenberg began her career at Morgan Stanley (MS, Fortune 500) as an analyst in the investment banking division. Her strong quant skills quickly funneled her into the private equity group, a move that allowed her to circumvent the traditional analyst-associate-business school route that many of her peers would follow.
Less than two years into her stint at Morgan Stanley, Goldenberg was one of the first young investment bankers to be picked off by the hedge fund industry. She left to work for Highbridge Capital Management. Brahman Capital’s management team was so impressed with Goldenberg’s questions during an investor meeting, that they recruited her away from Highbridge.
Goldenberg focuses on European special situations / event driven investments. As markets become more efficient with quant/algorithmic strategies coming online, I think we’re going to see an increased emphasis on finding value in areas of the market where it might be difficult to discern value. Goldenberg reports that most of the companies she looks at have a history of depressed earnings which are then fixed when a new manager comes in:
Fortune: What has been the driving force for you as an investor?
Goldenberg: I was trained early on to focus primarily on management quality. If you follow brilliant management teams, it will lead you to brilliant investment ideas. It’s pattern recognition.
At Highbridge, I was able to hit the ground running because I was hardwired to look at things the way they did. I was looking at a universe of European companies that were mismanaged and had depressed earnings. They had cost-cutting and capital allocation opportunities that were far better than their U.S. counterparts. But their share prices didn’t reflect that potential. We knew that the right management teams could turn these companies around. And no one else was terribly interested in them.
These kinds of companies might have been unappealing when looked at on a screen or maybe had too much headline risk. It’s easy for companies with these characteristics to be skipped over. I always look back to McDonald’s starting in 2003 when they initiated their “Plan to Win” program. The management at McDonalds had been hit by issues with their international expansion but also the PR backlash from movies such as Super Size Me. So they decided to manage with a goal to maximize return on invested capital (ROIC). They altered the franchise/company owned store mix, sold off underperforming divisions in places such as Latin America, and revamped their menu. For shareholders it worked out well with annualized returns of about 60%.
But investors looking at the company might have missed that. Some screens can only give you a backwards picture of what is happening so it’s up to the analyst to dig deeper and determine if things are going to change.
The other thing that I think is important is asking the right questions. If you listen to conference calls, sometimes a caller will ask a question that could have been easily answered by just reading through the 10-K. Recently, I spoke to an executive who came out of retirement to head up a REIT. To me, the most pressing question to ask was why he decided to come out of retirement, he had sold his company at the top of the market which really solidified his reputation as a great real estate dealmaker. So when I called him up, I asked him why he decided to gamble with his reputation for this company. It can sometimes be very valuable to get more insight into how these executives see the world and their competitors. I like to ask two competitors the same questions and then check what the differences are.
I thought this was great:
What would you say is your competitive advantage?
I can get a management team to articulate an idea that will cement an opportunity that other colleagues perhaps can’t get. It’s communication, but it’s stylistic. I think it stems from meeting with hundreds of CEO’s year after year and really listening to, and learning from them. And asking the right questions.
We recently met a Finnish guy who spent 18 years at P&G (PG, Fortune 500) selling laundry detergent and Sunny Delight. He’s now running a sporting goods conglomerate in Finland — with totally different products and different distribution challenges.
Instead of saying, “What the hell do you know about a sporting goods company?” We looked at it the other way. We asked, what did it take for him to step out of eighteen years at P&G, where he had $25 billion of revenue. What did he see?
I asked him, “How many opportunities did you turn down before you took this one?” The answer was over 20. But when I asked, “Why did you take this one?” It was totally obvious.
There were brands in this portfolio. Wilson for instance, with 2% market share. Not 20% like you might think. Wilson had tremendous market power that hadn’t yet been realized. There’s enormous brand equity there.
Our investment had nothing to do with the business, per se. We didn’t even identify a market opportunity. We just knew enough to talk to a guy who left P&G after 18 years.
There’s a flip side to this as well. When some people talk to CEOs, they end up drinking the Kool Aid. CEOs are good salesmen so at times they might exaggerate the truth or underplay certain problems. When I talk to a CEO or a customer or supplier, I try to remain objective and skeptical. If you talk to an ex-employee who is extremely negative, you need to qualify their arguments by talking to other ex-employees. You need to determine whether or not what he is saying is indicative of the truth or if he’s just disgruntled.
Sometimes people think that economic incentives will be enough to make sure that a CEO acts accordingly. This isn’t always true. There were a lot of bank executives during the crisis who had their banks fail or acquired at take under prices. In the case of the big investment banks, some executives had tunnel vision and didn’t truly understand the risky activities their bank was involved in, even though they personally held a lot of stock. Banks are also tricky because the CEO might just not have a whole lot of control over the business. Banks are beasts driven by the overall economy, even a great CEO can preside over a bank failure in that case.
If you have time, talking to people that are involved in the business or industry that you are looking at makes a lot of sense. It can actually be a mistake to not do this. 6 months ago I looked at a company that appeared on certain value screens, the liquidation value of the company seemed to be well in excess of the current stock price. Quantitatively, this investment made sense. But in investing, there is often a mixture of quantitative and qualitative factors at work. In this case, the CEO’s business was operating in a trough period and consuming large amounts of capital quarterly. For shareholders, the CEO should have liquidated the business slowly and distributed the proceeds. Instead though, if you had read the proxy filing and heard him speak at conferences — he seemed much more interested in trying to keep the business alive. That was bad because it meant that he might seek out a dilutive equity raise or a potential sale to another company at a price which might be below liquidation value. I chose to pass on the company and watched it fall as much as 30% in the proceeding 6 months.
So how do you get started with talking to CEOs and other executives? First, I try to read all of the public filings related to the company. The Ks, the Qs, and the proxy filings. I want to learn the business and then get an idea about the incentives at work for the people running the business. Then I usually spend a bit of time researching the CEO himself, a simple Google search might yield information regarding their spending habits (perhaps the CEO is building a lavish mansion) or their personal history, maybe the business is predominantly family owned and it’s always been passed on. Then you want to think about the drivers of the business, for a bank that might be loan growth.
So you could ask the CEO what it would take for them to start making more loans — maybe the local business climate is really bad. You could then talk to the people at the chamber of commerce and see what they are doing to try to improve the economy for the town. If a massive company is coming to town and opening up a branch, that might bring an influx of jobs and development, spurring loan demand. Or, if it is a distressed bank, you might try to talk to locals that are involved in the real estate business to get a real feel for what’s going on over there. Real estate is one area where things can differ vastly from city to city, so you can’t just look at aggregate data.
You have to dig deep. You’re best bet is just to keep at it. Chances are you wont be very good at first. One thing that might help is to read conference call transcripts and see the questions that analysts ask CEOs in the same industry. In time though, you’ll be able to develop a good rhythm and start asking the right questions.