It isn’t easy to find decent investments nowadays. Recently I was asked about investments in multiple “exotic” vehicles from “investment grade” wines, art and real-estate in Africa. I kid you not. I believe in investing in viable businesses that produce strong cash flows and are traded below their intrinsic value is the way to go, it’s pretty common sense to me. However, in this environment it is very difficult to find new investment ideas so one place I like to look at is the letters of the big boyz — the leading hedge fund managers.
In the stock market, one does not get points for originality or novelty. At Eden, as a regular part of our search for ideas, we review what leading hedge fund managers are doing and once in every while, we get intrigued by some ideas and start our own research into them. In this post I’m sharing some ideas from the hedge fund industry titans. Most of the funds that I mention here are big in size and they can’t look into opportunities in small companies — something that we at Eden can do but that’s not the topic of this post so without further ado let’s get going…
Bill Ackman, Pershing Square
At night, when most of you are sleeping, most hedge fund managers dream of something called “permanent capital.” That is a capital base that is not subject to randomly-timed redemptions from investors but rather a stable capital base that allows the manager to focus on long-term value creation and pay little attention to marketing the fund and dealing with investors.
On October 1st, Bill Ackman realised that dream with the IPO of PSH (Pershing Square Holdings) in Amsterdam and raised $2.73bn from new investors. This is money that he can invest free of short-term performance pressure.
Personally, I really like Ackman’s investing style and to me what he does resembles what Private Equity funds are doing, only that he does it in public companies. He succinctly put it in his letter: “Our “subsidiaries” are represented by large minority stakes in a handful of public companies. Typically, we are the largest or second largest shareholder, may have representation on the board, and, at a minimum, have substantial influence by virtue of our large stake and active voice.”
Here are three Ackman investments that I find worth mentioning:
- Fannie Mae: “We remain confident in the prospects for Fannie and Freddie and believe our investment in their common shares will ultimately be worth a large multiple of current prices”
- Air Products and Chemicals: Ackman pushed for a CEO change, similar to his successful activist campaign at Canadian Pacific , and it will be interesting to monitor the developments there.
- Burger King Worldwide: Teaming up with the wizards of 3G capital the operational turnaround of Burger King is probably something that will be taught in business schools few years down the road.
I’ll end this section with knowledge sharing that I can highly relate to:
Investment business – learned a lot over time. Started out buying cheap companies, now really emphasizes quality of business. Didn’t emphasize management at first, but Hunter at Canadian Pacific really shows the power of a strong management team. [Bill Ackman, Oct 2014 interview]
Dan Loeb, Third Point
Loeb known for putting a lot of money behind his best ideas and currently, his best idea and his strongest conviction seems to be Dow Chemical. His investment thesis involves some activism and value-creation advice. I found the thesis too difficult to comprehend but if the past is any guide, he will make a lot of money on this position as he usually does. Too complicated for me, however. Third Point’s holdings can be seen in this link and as you can see, not only does Dow’s common stock appear at the top of the list but also some call options.
One popular name among hedge fund managers nowadays is eBay. Loeb wrote a few things on eBay and PayPal on his recent letter to investors that can be found on this link.
With regards to PayPal, look at Loeb’s excellent stakeholder analysis:
Mobile payments have been “the next big thing” for almost five years but have failed to ramp. In part, this is because one needs buy‐in from financial institutions, merchants, and consumers in order for a payment technology to gain acceptance. With no pressure to catalyze a decision, the different incentives of these groups have not proven to be sufficiently aligned to overcome their inertia and come to an agreement.
I know that some eBay/PayPal employees are reading this blog — I urge you to read what Loeb write about it in the letter that I linked to above!
David Einhorn, Greenlight Capital
In October 2011 David Einhorn presented, with some fanfare, his “GAAP-uccino” short thesis on Green Mountain Coffee Roasters (GMCR). This short didn’t work out too well and David shared his learnings on his last letter:
While it would be tempting to write an entire book on our experience with this ultimately unsuccessful short, we will confine ourselves to a few paragraphs…
The gist of our thesis was that the company had engaged in various accounting shenanigans, the market opportunity would prove smaller than the bulls thought, and the 2012 patent expirations on K-cups would attract competition, limiting growth and margins. As far as we can tell, everything we said about the shenanigans is unrefuted and accurate. In any case, time has passed and these misdeeds are now dated…
The market is now saturated, and sales growth has steadily decelerated the last four years from 95% to 46% to 13% to 7%. 2014 earnings that were implicitly expected to exceed $5.00 per share when we presented, will be closer to $3.80 per share when the dust settles. However, the core of our thesis was that the company would lose its monopoly position upon expiration of the K-cup patents in 2012, and this has proven to be incorrect.
In response, GMCR management developed a clever strategy to re-close the system and preserve its monopoly position. It announced (and recently launched) a new brewer. While GMCR claims that the next generation brewer is for the consumer’s benefit, the principal new feature is that it recognizes and refuses to brew coffee from competitors’ K-cups.
We have the privilege of learning from his mistake. Shorts are a dangerous game anyway and it is recommended for most investors to stay away.
On his last letter, Einhorn compares Apple and Amazon:
AAPL is expected to grow revenues faster than Amazon.com, this quarter. Remarkably, AAPL still trades at less than a market multiple.
We added to our exposure of “Bubble Basket” shorts. AMZN’s recent disappointment is notable in that for years, the story has been that AMZN isn’t profitable because it is growing so fast. Now growth is slowing, but rather than unleashing higher profits, the slower growth is leading to even greater losses. One of the principal bullish assumptions supporting many bubble stocks is, “the company is growing too fast to be very profitable.” We think AMZN is just one of many stocks for which this narrative will ultimately prove false.
Einhorn closed his short position on Joy Global. Here is why:
Joy Global (short), sold at $66.72 and covered at $62.35. We prefer to be long joy, but in this case we shorted JOY because of our bearish view on Chinese steel production, which we thought would impact global demand for its coal and iron ore mining equipment. We covered at a modest profit because, though earnings declined sharply, investors seemed to be willing to assign higher valuations to industrial companies that are possible M&A targets.
At Eden, we are having a similar experience with Caterpillar. But we are more patient than Einhorn is. Until recently, Caterpillar hoped that the strength in it’s energy unit will make up for the weakness in it’s resources segment as mining companies are slashing their budgets left and right. With the recent drop in oil prices and some North American energy projects becoming not-economically-viable Caterpillar’s last hope might be fading away. In addition to that, there is a deflation in almost everything that CAT does because Chinese manufacturers offer similar equipment for the energy sector at prices that are about 40% lower while Caterpillar ceremoniously announced a price hike. I think that Einhorn was a bit early to cover this short position.
I hope that most of you had a good year with your investments, as 2014 is coming to an end we will share our results soon so stay tuned!