Street Capitalist: Event Driven Value Investments

Today I’m starting a new weekly (hopefully) feature at Street Capitalist called the Investor Book Club. Every week or so, I will post a “book club” entry introducing one or several of the books and articles that have influenced my thinking on investing.

The first book club selection is a bit off the beaten path, Richard Branson’s Losing My Virginity.

You might be wondering, what does Richard Branson have to do with investing? Richard Branson the billionaire who competes in death defying races around the world, launched a failed competitor for Donald Trump’s The Apprentice, runs an airline, and is even working on a space travel company. This does not sound risk averse, this does not sound like value investing. In reality, Branson is actually quite risk averse, he has been able to become a successful entrepreneur by taking minimal risks, similar to the Dhando-like low risk/high uncertainty method coined by Mohnish Pabrai.

The idea of value investing, or at least successful investing is the preservation of capital. We see the preservation of capital kept in mind at the beginning of the book when Branson applies it to his first real business. In 1968 Richard Branson launched a magazine called The Student, a publication that would cater towards the protest movement in London and cover topics that appealed to students of his age. The publishing industry is fiercely competitive, but Branson brought a margin of safety to The Student. Before even publishing its first issue, he made sure to sell out of advertising.

Most of them [advertisers] rejected the idea of paying for advertising in an unpublished magazine, but gradually I began to see ways of attracting their attention.

Even if the magazine failed to sell any issues, his losses would be minimal since the actual costs of the magazine had been paid for through advertising that had been sold beforehand.

Eventually though, competitive headwinds changed and Branson had to adapt. With the protest movement fading away, Branson sought to evolve his magazine into a new business.

I began to think of ways to develop the magazine and the “Student” name in other directions: a Student conference, a Student travel company, a Student accommodation agency. I didn’t see the Student just as an end in itself, a noun.

Branson realized that he could use his brand to sell music records to other students and shifted from using the Student as a brand and instead created Virgin, which would go on to christen railroad trains, airplanes, and even bottles of cola. One of the ingenious aspects of this whole endeavor is the fact that he sold the records through a mail order catalogue. By doing this, Branson could obtain fees up front in order to create a floor for his business venture’s value. The other benefit of a mail order catalogue was that Branson was always able to shop around for the best deal on records (sometimes taking advantage of arbitrage situations based on European taxes) while also giving him the benefit of not having to worry about managing large amounts of inventory. He was able to buy records more precisely to cater to his customer’s needs which helped keep costs down and allow him to undercut his more established rivals in the retail business.

Branson dedicates some of the book to a period when Virgin was a publicly listed company. While shares were floated at 140p, they fell during the year as England descended into a recession. Always the rebel, Branson chose to look the other way as the market panicked. He set his sights on Virgin’s rival, Thorn EMI and began to acquire shares because he thought they were undervalued. he says:

And since I was focusing more on the profits and cash flow from EMI, I began to see the stock market crash as a golden opportunity to buy the company… It simply cannot be true that Thorn is now worth only two-thirds of its value on Friday. We know the cash which we can earn from its back catalog, so in terms of straight cash to us it’s a bargain

Branson focused his attention on the actual financials of Thorn EMI instead of its stock price. With respect to Virgin’s own price at the same time he questions the logic of the market:

When we announced that Virgin’s profits for the year ended July 1987 had doubled, from 14 million to 32 million… our share price did not move upwards — anything but. It was difficult to understand how Virgin could have floated with a share price of 140p last year and to see our share price halved on the back of doubled profits.

These are lessons that still apply today, especially right now. In our negative economic environment, investors must keep in mind cash-flows and how the business is actually operating, not just a stock price. Branson basically figured out how inaccurate the stock market could be when assessing value and took advantage of it by building a stake in his undervalued competitor and taking Virgin private through a management lead buyout and then sold a portion of shares to the Japanese company Pony Canyon at a 52% premium above Virgin’s original IPO price.

With Branson, even an airline can provide an excellent margin of safety. A famous investor has said that: The quickest way to become a millionaire is to be a billionaire and buy an airline. Branson figured out how to prevent that. The airline business is one with huge capital expenditures, planes cost large sums of money after all. In order to start Virgin Atlantic while minimizing costs and cash outlays, Branson figured out that he could lease air-crafts from Boeing. This effectively capped the airline’s maximum loss at $3 million while leaving the sky as the limit for Virgin’s value. In an industry riddled with bankruptcies, companies like Virgin are hard to come by.

The second half of the book is mostly devoted to Branson’s battle with British Airways. It is an exciting read because we see the kinds of underhanded business practices British Airways employed as it tried to squash Virgin during their “dirty tricks” campaign. I found this section particularly interesting because British Airways used media disinformation campaigns and private investigators– tactics that we’ve seen in recent books and news stories. This section could be particularly useful for investors and managers who may one day find themselves in the same situation.

For me, the biggest lesson from Losing My Virginity is that starting a business does not have to be a high risk affair. Branson’s companies serve as a testament that this isn’t the case and that you can apply value investor principles to entrepreneurship and still obtain success. Benjamin Graham said that investing is best when it is most business like, but I’ve found that most investors (me included) have had little or no personal entrepreneurship experience. This book might provide some of the lessons and ideas that are needed to start changing that.