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Identifying the Next Outsiders


jschembs
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I think the holy grail of investing is identifying at a relatively early stage superior businesses led by CEOs who understand capital allocation.

 

This is easy in retrospect, but very difficult in advance.

 

I'd love the board's thoughts vis-a-vis the most important factors to getting comfortable that you may have found the next Henry Singleton. Here are my initial ideas:

 

1. High ROIC business with moderate growth prospects. Obviously more growth opportunities are better, but I believe sustainable ROIC is more important than growth.

2. Management interests aligned with shareholders - no (or minimal) stock comp. If there is stock comp, it is based off of economic earnings rather than EPS or EBITDA.

3. Significant management equity ownership.

4. [Here's the hard one] CEO who clearly articulates his/her approach to capital allocation, and that it's consistent with the Outsider CEO perspective.

 

Other thoughts?

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Tucows Inc (TCX)... CEO Elliot Noss mentioned as a small cap Henry Singleton.  Since, 2006, Tucows has taken nearly half of its shares outstanding off the table... that is some serious cannibalization!

 

-Steve

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"Good capital allocator" is a term you hear a lot lately.  i don't want to show my ignorance, but I'm not sure I know what a good capital allocator is?  It sounds like a finance function, but I have a feeling it isn't?

 

I view a "good capital allocator" as someone who shows acumen in determining the proper use of cash. Blindly repurchasing shares is not a sign of a good capital allocation.

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I know you are looking for these companies at an early stage but the proof is always in the pudding as they say.  You need some kind of track record to verify their capital allocation, otherwise it's just talk.  Also, a lot of the real outsiders worked into their 70's+, so no reason you can't have a 5 to 10 year track record and still make a killing.

 

Ideally I think you want a full business cycle to test on and you need variance in their actions.  Did they buy stock when it was cheap and issue when it was expensive?  Or, did they take advantage of the crash to scoop up competitors and pull back at the peak?  I see too many guys get called out for being buffets or john malone but their track record is only a few years long or worse, their preceding record is a long flat line.

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EPM Evolution Petroleum CEO Robert Herlin has basically turned $1 million in equity to a $400 million market cap company from a royalty interest in the Delhi oil field in Louisiana, in which they partnered with Denbury.  Now they're shifting to building out an artificial lift technology that can help declining oil fields bounce back from 5-10 b/day to about 100 b/day. They plan to earn a share of the increased production or sell/install the lift equipment on service contracts.

 

 

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It is not necessarily hard if you look in the smaller cap space. For example a company can have a great 10 year record of growth and capital allocation and still have a great deal of potential for further growth.

 

Think about if you'd investing in BRK after 5 years, and Buffett already had a great 10 year investing record. It still wasn't too late to let him turn your money into a fortune.

 

I think it's always important to look at track record because there are so many people that make all the right statements and noises yet their actions just do not deliver the results.

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People commonly mentioned on this board...  i.e. current outsiders

 

Nick Howley - TDG

John Malone - LMCA LBTYA LINTA and for other million things

Mike Pearson - VRX  (maybe Rajiv De Silva at ENDP)

Buffett, Gayner

 

Potential new idea I am working on... have not seen on the board

 

Ayman Asfari - PFC (Petrofac Ltd on LSE)

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I disagree that having a good capital allocator is a necessary characteristic. Good capital allocation is highly desirable in a larger holding firms with diversified, mature businesses, but for smaller, fast growing operations, I do not believe that "good capital allocators" are necessarily going to perform well.

 

I would prefer buying a firm with an excellent business model that has substantial potential for expansion.

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Guest longinvestor

The best capital allocators are those

1. Focused on not blowing the capital away. Avoid capitalizing an idea that should not be

2. Once an idea passes the the above test, ask if the price is right. Otherwise pass or at least wait, patiently.

3. Whe the price is right, back up the truck and load up. IOW, act with urgency.

 

The favorite CEO in whose co I worked in demonstrated these traits. Every week he got capital requests, many of them he'd deny or send back (#1 trait), when a worthy idea came up, he'd add it to the worthy idea list and ask for due diligence done on it if the price looked marginally attractive. (#2 trait). Very occasionally,  he would cll a signature party where all signers would be summoned to get a capital project approved. The idea was that good.

 

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Perhaps its a better idea to focus on your own capital allocation skills, because that is something under your own control. You never know people 100% and you can only say in hindsight that someone has allocated capital really well. But is he/she able to do it in the future?

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"Good capital allocator" is a term you hear a lot lately.  i don't want to show my ignorance, but I'm not sure I know what a good capital allocator is?  It sounds like a finance function, but I have a feeling it isn't?

 

From my understanding, a good capital allocator is someone who is dogmatic about investing only in areas that show promise of a return on capital that meets his hurdle rate and exceed his cost of capital. His priority isn't to sacrifice return on capital for the sake of growth - quite the opposite - someone who returns capital if there aren't attractive growth opportunities. This seems only possible for someone who benefits from increase in the per-share intrinsic value of the business rather than the total revenue of the business, hence business ownership and long-term view is key for the outsider. Most managers aren't outsiders because they get paid on the size of the business that prioritizes empire building even at the cost of mediocre returns.

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I think John Fredriksen and the Awilhelmsen Group of Norway have a strong track record.

 

Robin Raina at EBIX has a good track record too - he has rolled over so many companies without sacrificing margins and knows when to issue stock and when to issue cash. From 2005 to 2011, his share count has increased by 48% while the per-share revenue has increased 480% all the while increasing margins. This has led to an EPS growth of over 1000% in face of a 48% share count increase...

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I think John Fredriksen and the Awilhelmsen Group of Norway have a strong track record.

 

Robin Raina at EBIX has a good track record too - he has rolled over so many companies without sacrificing margins and knows when to issue stock and when to issue cash. From 2005 to 2011, his share count has increased by 48% while the per-share revenue has increased 480% all the while increasing margins. This has led to an EPS growth of over 1000% in face of a 48% share count increase...

looks like they had a bad year with all the litigation nonsense. What do you think about that? ALso why is their tax rate so low, and how will that look going forward?

 

It looks pretty cheap if business picks up next year. Easily a double with their growth prospects and ROIC.

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I think John Fredriksen and the Awilhelmsen Group of Norway have a strong track record.

 

Robin Raina at EBIX has a good track record too - he has rolled over so many companies without sacrificing margins and knows when to issue stock and when to issue cash. From 2005 to 2011, his share count has increased by 48% while the per-share revenue has increased 480% all the while increasing margins. This has led to an EPS growth of over 1000% in face of a 48% share count increase...

looks like they had a bad year with all the litigation nonsense. What do you think about that? ALso why is their tax rate so low, and how will that look going forward?

 

It looks pretty cheap if business picks up next year. Easily a double with their growth prospects and ROIC.

 

I feel like EBIX has been misunderstood and the management has been heavily distracted. I was a buyer around $10-$11/share and lower - I'm just holding here as I feel it has a pretty good business model. Tax rate is poised to gradually increase as we go forward and the overseas tax holiday comes to an end. At this price, the shares are slightly undervalued if you assume no growth but cheap if you think Raina hasn't lost his talent for acquisitions. Or you could just stay out of the stock until the investigation is resolved or if you can't handle the volatility.

 

For what it's worth, Don Braid of Mainfreight Ltd based in New Zealand is cut from a different cloth than most:

 

 

Wow - quite a track record! If I may ask - how does this compare to XPO and its chief Brad Jacobs? Definitely seems like an "outsider"! All we need is a handful of such companies to get very rich over time!

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Has there been any research done on people with similar early trajectories as the original "outsider" CEOs, but ended up not doing so well?

 

It's not *exactly* the same but you can look at the horizon kinetics wealth master index.  I don't know if it's been verified by a 3rd party but they claim that an index of individuals owning $100M+ of stock has beaten the S&P by 2.7% per year over the past 20 years.

 

http://www.horizonkinetics.com/docs/CC_112_Jun13.pdf

 

There are other studies you can dig up if you're curious that indicate that companies with large insider ownership tend to outperform.  Now a CEO with large ownership is not necessarily a great capital allocator but if you follows siddharth's definition of individuals who benefit by increase in per share value, certainly those with insider ownership would qualify.

 

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