Hello ScottHall,
First an admission: I actually wrote this article for the Value Institute. Also thank you for your comments – I love to get feedback. Yes, this article does not get into the specifics of the industry/companies. I can absolutely understand that this is not what you are looking for. It was designed to discuss the generalities of the phenomenon in question. Getting into the detail is something that we sometimes do (for example we recently wrote in detail about the dental implant business). We find that many readers actually prefer a broad summary of the issues unless they have a keen personal interest in the topic at hand.
Also, whilst I have a good grasp of the salient features of the industry, I admit that I haven’t done detailed work on the companies mentioned. This is because I know, after initial analysis, that these companies are not of interest to me on the long or short side. This is why I am not making any definitive statements about the companies in question. I am also intrigued to see some very smart money on the long side (e.g. Valeant: Ruanne Cunniff, Brave Warrior). However I am also intrigued and even stunned at the dramatic change in sentiment and strategy in this sector and, for choice, I see some warning signs that I don’t really hear many others talking about. In this sense, think of the article as an overview of reasons to think a little about what might go wrong here.
In regards to your comments about how to think about the structure of earnings (maintenance and growth component), I agree. The problem is, I believe, that this is beyond analysis – I don’t believe this can be done with any degree of accuracy as there are simply too many unknowns in the analysis (too many markets, too many deals, too much restructuring, too many ‘adjusted’ numbers), but conceptually this is exactly the way to think about the issue at hand. By extension, another problem is that people seem to be valuing these stocks by applying a multiple to the adjusted earnings/cash flows. It is my belief that these earnings probably do not incorporate the cost of replenishing the capital stock (though, as alluded to, I don’t think this number can be quantified) – so while many of these deals might add value on a IRR basis, perpetual valuation tools like PEs are probably not suitable here.
In relation to the comments from Liberty, I don’t think there is a smoking gun (no reason to assume any fraud or any cataclysmic collapse of the strategy). I also fully accept that there may be managers with acquisition skills comparable to Buffett or Stiritz but how will you know in advance? In general, most acquirers won’t possess the skills required to add value through acquisitions – the investor must be very confident that he has the skills to spot the Buffett from the “Bluff-it” (and most will fail in this respect).
Thanks again to you both for your comments.
Makisig