The Oaktree Capital and Brookfield Marriage

I had the pleasure to be back on The Intelligent Investing Podcast with Eric Schleien to discuss the Brookfield-Oaktree transaction. Below are some notes on the transaction.

Bruce Flatt from Brookfield Asset Management and Howard Marks from Oaktree Capital Management are getting tie up. Two of the brightest investment mind are coming together. This is a deal where best in class meets best in class. It’s a win-win situation for both Oaktree and Brookfield.

Howard Marks doesn’t need an introduction. Marks built a reputation for making sharp bets on undervalued assets and in the process becoming one of the most famous figures in investing. Marks is frequently seen sharing his wisdom on financial TV and is active on the public speaking circuit. His memos, full of insights, are must read material. His first book, The Most Important Thing, is outstanding and has been endorsed by Warren Buffett. Read it. Marks has a new book out, Mastering the Market Cycle, but I haven’t read it yet. As for Bruce Flatt, I’ve covered him in the past here, here, and here. Flatt might not be as well known as  Marks, but his investment record speaks for itself. You can read the latest shareholder letter here. Here are BAM’s performance:

BAM Performance
Brookfield Asset Management Performance. Source: BAM 2018 Shareholder Letter

The Deal

  • Here’s the press release.
  • BAM is buying 62% of OAK for $4.7b.
  • 38% will remain with current management
  • Brookfield will acquire all of Oaktree’s publicly traded A shares for either $49 per share or 1.077 Brookfield shares. This is a 16% premium over the 30-day value weighted average price. Or a 12.4% premium over the closing price before the announcement.
  • It is also buying 20% of the privately held B shares for a total of 62 per cent of the business.
  • Total consideration paid by BAM will be 50% and 50% shares.
  • BAM can be a total owner at the earliest in 2029, pursuant to a liquidation plan that starts in 2022.
  • OAK employees has 92% voting power.
  • The combined entity will have $475 billion in assets (BAM $355b + OAK $120b). The deal will put it in the same region as Stephen Schwarzman’s Blackstone (BX).
  • BAM is expected to earn $2.5b in fee related earnings.
  • Both firms are expected to stay independent.
  • BAM will have 2 board seats on OAK.
  • Howard Marks will have a board seat on BAM.
  • The entities can’t be fully integrated because they want it that way, but also for regulatory reasons.
  • OAK will keep their brand, management, and investment teams.

Why?

Continue reading “The Oaktree Capital and Brookfield Marriage”

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On Star Stockpickers

We have a fascination with stockpickers. Big name stockpickers like Peter Lynch or Carl Icahn, comes to mind. Star stockpickers are glamourized because investors think they have the magic wand to make fast and easy money. They know the secret to the next big name that will make them rich. And when you hold the secret to riches, the star stockpicker gets outsize attention. The star stockpicker appears on magazine covers and TV. Barron’s Magazine dedicates an annual roundtable to them. It’s very tempting for an investor to follow the recommendations of the stars. After all aren’t they the best of the brightest? They have done the research and analysis. Their past returns are juicy. They look rich and successful and you probably want to put your money where their mouth is.

First, it doesn’t work that way. Getting rich off stock tips would be too easy and it’s not supposed to be easy. I don’t know anybody who got wealthy buying stocks off a one minute TV pitch. However I’m pretty sure I can find a good sample size of unrich people that took the dive.

Second, let me hit you with the classic buzz killer “past performance is no guarantee of future results”. Why does every investment disclosure insist on including the oft-repeated phrase? Aside the legal obligation and the statement hold its weight in terms of truth.

The phrase also goes to the heart of something important if you want to make intelligent decisions and manage your risk: It is the process that counts, not the recent scorecard. There’s more on this below.

Third, chasing high returns can cause problems for your portfolio. The typical stock pitch is in a hot sector and as a result viewers pull their money out of their other investments and pour it into the new object of their affection. The investor is reacting out of emotion, most likely greed or the fear of missing out (FOMO). There’s no shortage of study documenting that investors are constantly buying and selling at the wrong time.

Fourth, there are many things we don’t know. There’s a lack of information. There a chance that we don’t understand what we are investing in and that can lead to trouble.

We don’t know the motives of the stockpicker. Is the stockpicker doing this out of self-interest? Is he trying to pump a stock where he has a loss position? Is he trying to raise money for his new fund? Is he trying to get a particular company’s business for a stock issuance? Or maybe he is simply trying to help us. We ignore “the when” and “the why” that triggers the stockpicker to get in and out of his recommendation. We don’t know when the stockpicker changed his mind and got out of the position. The viewer might be tempted to invest a sizable amount with the aim of making good money. But the allocation to the stock recommended is likely a small percentage, much likely less than 2-3%, of the total portfolio.

Fifth, some stockpickers have the “it” factor. “It” is the personality to make great TV. You are not going to see a boring Carl Icahn interview. He squared off against Bill Ackman in one of financial TV’s most interesting moment. But if you followed Carl Icahn in some of his purchases, like SandRidge Energy or Hertz, you would have seen your investment melt 60% or more. The mix of the right personality trait and charisma can get to somebody’s head. I should mention that not all star stockpickers are in media hungry. Seth Klarman of Baupost Group has been labeled media shy.

My take on star stockpickers can be seen as overly negative. I don’t want to disparage the individual pitching stock. They are not doing anything wrong. They are fun to watch. It’s entertainment. They are smart individuals and some of them are very successful, like Carl Icahn despite what I wrote in the previous paragraph. I believe they have the right intention and after all the whole point is to make money.

So what should you make of this?

Of course you might make money off the occasional stock pitch just like you can hit red at the roulette table. There’s an element of luck and speculation has its moments. I’m not saying you can’t money off ideas sourced on TV or in a magazine. It’s the behavior that is wrong. Jumping on the cool stock of the moment violates the bigger picture. Speculation violates the “why” you are investing.  You have a plan to build long-term wealth and bandwagoning on cool stocks is not contributing. I understand that respecting the investment process is not sexy. But messing around with your retirement fund or pension plan is not supposed to be sexy. And losing money is very unsexy. One bad decision can be a killer for your portfolio. Don’t forget that the beneficiary is you. You are impacted by your decisions. Humans are terrible are market timing. Studies after studies mention that asset allocation is responsible for 90% of the returns. Not picking stock skills and not hot TV stocks.

If there’s one thing to retain is that the next time you get a hot stock tip, resist the urge to open your trading app on your mobile to have a feel good moment. You can wretch your portfolio with just a few clicks.

Berkshire Hathaway 2018 Shareholder Letter and Interview

*Update: I fixed the link to the podcast.

I reviewed the Berkshire Hathaway (BRK)’s 2018 letter and listened to CNBC interview that followed. I also share my comments on The Intelligent Investing Podcast with Eric Schleien from Granite State Capital Management.

My Take

During Warren Buffett’s career of over sixty plus years, whatever needed to be said about investing has been said. You are not going to get a shocking change of opinion from an 87 year old man. The latest letter doesn’t contain any surprises and he was notoriously sphinxlike during the three interview on CNBC. Buffett can talk for hours but rarely said anything that you could use.

There are things that never change. The letter contains what you would expect, including the classic hits; “I’m younger than Charlie”, “stocks are better than gold”, and “invest in an index fund” among others.

Warren used his shareholder letter to talk to his shareholders and to educate them. Now he probably feels like he’s writing the letter for everybody to read. It gets picked up in the media and is quoted everywhere. If you are an investor looking for more technical content, the Warren Buffet Partnership letters are great.

Warren Buffett is a household name. When you think of the greatest golfer of all time, Tiger Woods comes to mind. When you think of the greatest investor of all time, you think Warren Buffett.  When you achieve this level of fame you have an outsize audience. The new investors, students, people with savings, professional, and non-investors are turning to you for advice. Warren realizes that he has to be careful with what his words.

However I will mostly remember this letter for what’s wasn’t being said.

  • In the letter Buffett talked about “diseased trees”, companies that will not be around in 10 years. No details on that out of respect for the workers there. But I think as a shareholder I would like a little bit more clarity.
  • I wish there was a deeper look at industrial businesses.
  • No comments on Apple, which is now the 2nd biggest position on his equity portfolio.
  • It would be fun to hear from the investment managers Ted Weschler and Tom Combs, and from Greg Abel and Ajit Jain. Maybe they can write a letter too?
  • No details on his Fintech investments, Paytm and StoneCo.
  • No details on his healthcare venture with JPMorgan and Jeff Bezos.

In the letter Buffett talks about focusing on the forest and not the trees (the companies), and he divides his trees into five groves to simplify things. I appreciate anything that simplify life. But as an investor in the company, I should know more about BRK’s investments. I like to learn about bushiness. I would like to learn more about the companies inside BRK, not just the 4-5 big ones. I don’t need a full 10k of details. For example: It would be fun to learn about what is Brooks working on? What’s their vision of the shoe of the future? Where do they see the company in five or ten years? How’s Dairy Queen doing?  It could be a paragraph or two. I understand there are like two hundred companies. Since BRK decentralized everything, the manager of these companies can write a separate report. Brookfield Asset Management, another company with many moving parts, does a good job talking about their various investments without getting immersed or entangled in details or complexities.

For Berkshire Hathaway, I see three possible paths forward.

  • Return cash. Accept that BRK must be less ambitious but will likely not go down that path.
  • More takeover but expensive. That’s Buffett preferred route.
  • Wait for a crash and load up on stocks.

The Letter

I reviewed Berkshire Hathaway (BRK)’s 2018 letter and listened to the CNBC interview that followed.

Here are some notes:

BRK outperformed the S&P 500 for the third year in a row, 4 out of the last 5 years, and 7 out of the last 10 years (2009-2018). The shares increased at a 17.3% (11.5%) CAGR during 2013-17 (2014-18), compared with a 15.8% (8.5%) average annual return for the S&P 500.

It’s worth noting that BRK’s returns are after-tax and the S&P are pre-tax with dividends included.

2018 Returns:

  • Per-share change: 2.8%
  • Book value per share: 0.4%
  • S&P: -4.4%

Compounded Annual Gain per share from 1965-2018: 20.5% vs 9.7% for the S&P 500 (dividends included). Over the past 54 years, book value has increased from $19 to $348,703.

It’s amazing that BRK can still outperform at its current size ($500b market cap). For the longest time, Buffett and Munger remind us year after year that they do not expect to outperform the S&P but they still do. BRK is the 7th largest most-valuable publicly traded company. The other 6 are tech companies. I do not expect Berkshire to be able to consistently increase its book value per share at a double-digit rate going forward–a feat the firm achieved six times during 2009-18.

Regular readers of the annual letter probably noticed that Buffett diminished the annual change in BRK’s book value because over time that number has become out of touch with BRK’s economic reality. What really counts of course is per-share intrinsic value. But that’s a subjective figure and book value was a useful tracking indicator when book value and intrinsic value were much closer. For the large majority of its existence BRK’s assets were then largely securities whose assets were continuously restated to reflect their current market price.

Today BRK has shifted in a major way to owning and operating large businesses and many are worth far more than their cost-based carrying value.  That number is never revalued upward. Consequently the gap between BRK’s book value and intrinsic value has material increased. That’s why BRK has introduced the historical record of BRK’s stock price to the performance table.

In the letter Buffett cited three main reasons for that:

  • BRK’s value is now mostly derived for the operating businesses that it owns. It used to be derived from its massive stock portfolio
  • Accounting rules dictates that equity holdings are marked-to-market (market prices) and operating companies at their cost-based carrying value, which is below their current value and not reflected in the financial statements.
  • BRK will likely buy more if its shares over time above book value but below intrinsic value. If you do it right, each transaction will make per-share intrinsic value go up, while per-share book value will go down.

BRK’s intrinsic value far exceeds book value, that’s why it made sense to repurchase shares at 120% book value made sense. Now that policy has been dropped and BRK now repurchase shares when it feels it below intrinsic value.

2018 Earnings

BRK earned $4 billion in 2018 and how we arrived at that number is broken down below.

Buffett 1

Because of the new mark-to-market rule, the last item brings wild swings to the bottom line. BRK has an equity portfolio of $173 billion. So a 1% change is either a 1.7% accounting gain or loss. The $20.6b loss was no actually triggered.  It’s a change in value. It’s an accounting number that distort the true economic value of the company. That’s why it’s important to focus on the operating earnings. Operating earnings is a better performance metric than net income, since the latter is subject to numerous accounting rule. Continue reading “Berkshire Hathaway 2018 Shareholder Letter and Interview”

The Intelligent Investing Podcast – Berkshire Hathaway 2018 Letter

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*Update: I fixed the link to the podcast.

I reviewed the Berkshire Hathaway (BRK)’s 2018 letter and listened to CNBC interview that followed. I also share my comments on The Intelligent Investing Podcast with Eric Schleien from Granite State Capital Management.  I’m currently writing a post on the topic which will be available soon.

This is one of my shorter podcast, it’s only 25 minutes long. You can listen here:

Connect with Eric Schleien:

Visit Eric Schleien’s PODCAST: http://intelligentinvesting.podbean.com

Visit Eric Schleien’s WEBSITE: https://www.EricSchleien.com

Visit Eric Schleien’s TWITTER: https://twitter.com/ericschleien

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Follow Eric Schleien on FACEBOOK: https://www.facebook.com/eric.schleien

Visit Granite State Capital Management’s WEBSITE: https://www.GSCM.co

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Survivorship Bias

Survivorship Bias
Credit: https://xkcd.com/1827/

 

Fyre Festival Scam

Me and my wife watched the Fyre Festival documentary on Netflix. We only watched it under recommendation of my brother because the trailer wasn’t appealing to us (kids partying on the beach with Ja Rule…pass). My brother’s track-record of recommendation is rock solid, so we gave it a shot. I told my wife let’s give this thing 10 minutes and we ended up watching the whole thing.

While the documentary focus on the Fyre Festival fiasco, there are lessons for the investor. The head of the group, convicted fraudster Billy McFarland, took everybody for a massive epic failure of a ride. It reminded me of Theranos founder, Elizabeth Holmes. She was the perfect package and turned out to be the perfect fraud. While Billy wasn’t as refined or smart as Elizabeth, he always had some kind of hustle on (mostly scams). Billy had ambition, vision, and could talk a great game and people fell for it. Here are 3 key ingredients for a great person: brain, energy, and integrity. If you have the first two and no integrity, you have a recipe for disaster. That’s when people like Elizabeth Holmes and Billy come in. They are terrible for society but they make a great documentary.

The lesson: Have a healthy dose of skepticism. When pitched with the a revolutionary way of doing something, a great idea or an awesome product, make sure that the people involved have integrity. Because if you bet on a person with high energy, high intelligence, but low integrity and you’ll get a smart, fast-moving thief.

This is what they promised:

  • The biggest party of the decade on Pablo Escobar’s old island
  • A line up of musicians, artists, celebrities.
  • Supermodels everywhere
  • Private jets from Miami to bring guests
  • Gourmet food
  • Luxury villa
  • A treasure hunt with over a $1m in prizes.
  • Party yachts

What was delivered:

  • A dump of a site with hurricane relief tents.

A lot of people got burned. People paid a lot of money to show up to realized they got scammed. A lot of hardworking people didn’t get paid. Investors got ripped off. Everybody got ripped off. Expectation and reality clearly weren’t aligned. Billy is probably safer in jail.

Related imageImage result for fyre festival expectation vs reality

The gourmet food:

While the website promised 'chef-curated culinary pop ups' one reveler posted a picture of a basic cheese sandwich served out of a polystyrene box. McFarland claimed that this picture was fake and not actually taken at the festival 

McFarland was charged with defrauding investors by presenting them with fake documents while seeking investment in his company, Fyre Media. He’s currently in jail for 6 years/

Billy McFarland

 

Capital Allocation Presentation

Phil Ordway from Anabalic LLC has made a great presentation on capital allocation. In everyday parlance, capital allocation is “how you use cash”. Everything involves tradeoffs based on opportunity cost and how you evaluate these tradeoffs is essential.

For those who read the excellent book The Outsiders (read it if you did not), you will enjoy Phil’s presentation. The presentation goes a beyond effective capital allocation. It address three things companies need to do that everybody would agree on.

  1. Effective Capital Allocation
  2. “Good” shareholders
  3. Meaningful communications with stakeholders

Point #2, “good” shareholders, is interesting and definitely not talked about enough. I’m glad Phil brought it up and should be the subject of further studies. Just having the “right” shareholders can make a significant difference. Think of the effect of having Warren Buffett as a shareholder did for Graham Holdings (The Washington Post). Point #3, meaningful communications with stakeholders, is not done properly. Most companies have some kind of Investor Relation “IR” department but don’t communicate properly.

This presentation is for investors, board members, executives, and anybody that runs a company.

Here’s a bonus presentation from William Thorndike, author of The Outsiders”.

Podcast: Investing in Cuba

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Copyright Eric Schleien

I was back on the The Intelligent Investing Podcast with Eric Schleien of GSCM to discuss Cuba. In a previous post I talked about my recent trip to Cuba. While the post has more of a global approach to Cuba (politics, economy, reforms etc…), the podcast is more geared towards investing. Of course they are opportunities but it’s not easy to invest in Cuba and it would require a lot of work (even more if you American).

The podcast is a about 45 minutes long, perfect for the work commute. If you can’t stand my accent, or you prefer reading, Eric published a transcript on SA.

Other platforms:

Joel Greenblatt – Great Value Investors Need To Be Cold Hearted JellyBean Counters

Here’s a great video by Joel Greenblatt, author of You Can Be a Stock Market Genius,  with less than 3,000 views. In a segment, he talks about how outside influence, or “group think” affects our judgment, and basically on how we price stocks.

 

The Bond That’s Still Paying Interest, 280 Years Later

Here’s a lesson in inflation. The WSJ has an interesting story on bonds that are perpetual. They will pay interest forever as long the issuer doesn’t default. While that sounds nice, the problem is inflation will eventually eats your income away. Remember your grand-parent’s stories about how far they could go on with $1? That same dollar today lost its purchasing power. That’s inflation. It’s also a reminder that some debts never really die.

Reposted from The Wall-Street Journal

By Christopher Whittall and Georgi Kantchev

The French government has owed Marie Verrier’s family money for a long time. Almost 300 years.

All Ms. Verrier and her husband, Jean, have to do to claim the world’s oldest government debt is prove they are the descendants of an obscure 18th-century lawyer.

The question is whether it’s worth the effort: Three centuries of inflation and shifting currencies mean this debt yields just €1.20 a year, the modern-day equivalent of the long-defunct livres the bond was issued in.

“That [yield] would allow you to buy a baguette of bread once a year,” said the 81-year-old Mr. Verrier from the couple’s home in the Parisian suburb of Asnières-sur-Seine.

Bonds that never mature, or do so after a century or longer, aren’t just museum pieces. The ultralow interest rates of the last decade have encouraged governments and corporations to borrow for increasingly long periods, with some even selling 100-year bonds now.

Argentina, Mexico, Oxford University and the Wellcome Trust, one of Britain’s largest charities, have been among the issuers bonds that will mature in a century. Countries including Japan and Germany have issued so-called perpetual bonds, which never mature. Continue reading “The Bond That’s Still Paying Interest, 280 Years Later”