We will also be hosting a follow-up Q&A with Chuck. If you have further questions for him, post them in the comments below, and he will reply.
1. I have a couple of questions for Chuck on Lamar (LAMR).
What does he think the ultimate ratio of digital billboards to total billboards will be for the company? I have heard anywhere from 3%, 5% or 10% over the next decade. Also, does he think smart phones hurt billboards or enhance them? I believe this important because an iPhone is really just a mini personal billboard. It could hurt the overall appeal of billboards or could be used to interact with them. Lastly on capital allocation, the Reilly’s seem very capable but at the top of the last cycle they paid a special dividend and bought back stop at prices above today’s stock price. Do you think they learned a lesson and that capital allocation going forward will be different? Would love to hear his thoughts. Thanks.
[Akre] Three questions: a) I have no idea what the ratio of digital boards to the total will be, but I do know that there is a very large upside opportunity. B) Smart phones are indeed mobile boards, and again I have no view on whether they will supplant fixed boards, or rather enhance them through a mobile link of some sort. Lots of possibilities. C) Certainly in hindsight the special dividend and share repurchase was fuzzy thinking. More recently the option strike repricing (although the dollar amount remained constant) continues to reflect poorly on a corporate governance philosophy. Fortunately the business seems to be run reasonably well. I am told that Brent McCoy’s role at the firm is to oversee capital allocation issues, and so we might expect improvement.
2. How much do you think your returns would have increased in 2008 if you considered the macro picture into your stock selection?
[Akre] Munger and Buffett said at the 2010 annual meeting that they would not be attracted to any manager who went to cash during the crisis. However, they held 20% to 30% cash during the crisis, giving them great opportunities and reducing their exposure to the downside. Our returns of course would have been better if we had had the insight and courage to go to cash, but we did not. What I have said is that I want to better incorporate my “world view” into my security and portfolio decisions, with a view that we might better. What the balance of 2009 and 2010 have taught us is that things were not a s bad as they felt at the time, as portfolio values have recovered nearly all the lost ground. It just felt awful going through the “troubles.”
3. I also own Markel (MKL) shares and I really like the company and consider it a permanent holding (unless it trades at 3x BV).
What is your estimated range for the BVPS growth rate over the next 10 years?
What’s your opinion on the companies that comprise Markel Ventures? Have you verified the prices paid? How about the quality of the individual businesses and their competitive advantages?
[Akre] I think under their current structure (especially investments to book value) they should be able to compound book at a low- to upper-teens annual rate. I have not examined the Ventures businesses closely as MKL has had limited disclosure. I have spoken with the CEOs of several at various functions and they are the types you would expect. Several are growing rapidly, and several are the types I call “send the check to Omaha.”
4. I noticed you scaled back your position in Penn Gaming (PENN). What are your thoughts of this company going forward?
[Akre] Peter Carlino (CEO & chairman) is the best in the business at compounding the shareholders’ capital! We continue to believe that the triple head-winds (competition, taxes and sluggish economy) just make it more difficult now.
5. As a student dreaming of a career like yours, I was hoping that you could give me some advice on finding some good topics for writing a thesis/essay about. Of course, I'm looking for topics that would help me in a stock-picking career.
[Akre] Compound returns!
6. Recently I have been watching stocks with absolutely no company revenue take off on "paid promotions." Most notably LEXG went from $0.10 to over $10 and back down. Jammin Java was similar in its performance to a high of $6.35 from below $1. What do you consider to be the single most important factor in considering investing in stock, technical analysis, due diligence or news? If news is the most important, how can one "predict" that a stock will run, or is it simply risk?
[Akre] Fundamental analysis is the most important. One needs to know what one owns as an investor. Of course if speculation is your game, you can try anything.
7. I'm planning to take CFA and learn to become a good value investor. I'm about to start my job at PwC and after three years to enter into an investment bank and was wondering, will auditing help me achieve my goal? Thank you.
[Akre] Accounting is the language of business, so anything you do to improve your understanding of accounting is valuable. I don’t personally believe that an investment bank role will help you become a better value investor, as their focus (rightly so) is on creating transactions.
8. In a past shareholder letter, you expressed concerns about the so-called recovery (high unemployment and weak consumer). Would you please share your current view on this topic and how it relates to market expectations moving forward? Also, would you relate this same question to your expectations for the portfolio's performance?
[Akre] I continue to believe that the current high levels of unemployment and underemployment will continue to hold back recovery. This backdrop quite logically will affect the investment climate. Further, I have no prediction about how any of our investments will perform over the balance of the year (or even next year for that matter), but I do know that each will gain in economic value per share both this year and next. How the market values that is unknown.
9. Now that you are beginning to think of the macroeconomic factor, what are the most key factors you are looking at?
[Akre] I have always tried to be tuned in to what is happening in the world around me, but since the end of 2008, I have been trying to better integrate that view into individual security selections.
10. Having lost a bundle this year on a delisted stock, I have to be very cautious of both company-specific risk and macroeconomic risk. In your opinion, should a risk-averse investor wait to see if the FED ends QE2 in the next weeks/month before deploying cash that is quite limited? I am also of the age (mid-50s) where I should have a much smaller percentage invested in riskier equities compared to someone 20 years my junior. I am thinking of staying in cash for at least a month, then venturing back depending on the outcome of FED changes before the end of summer. I will never make up for the 90% downside I experienced, but if I catch a bottom in commodities just after a QE3 (if such happens) or after the market is finished worrying about the ramifications after QE2 ends, 2012 might be a good year for another oil stock run since it is a presidential election year.
[Akre] Perhaps your personal financial goals aren’t suited to your plan of speculation, and at the same time you cannot reach your goals without speculation. If that is the case you have a real dilemma. As an investor, I have found very little success at trying to time my portfolio purchases and sales around macroeconomic events. Instead, I try to understand the business (using my three legged stool model) and make purchases when the valuation is attractive.
11. My first question is on portfolio management. You run a very concentrated portfolio with a very low turnover — 24 stocks with 75% of assets in top 10 holdings with an average turnover of 12%. How do you manage to maintain such a low turnover concentrated portfolio when your assets are growing, without compromising the price discipline required of a value investor? Put another way, I imagine that when a new position is initiated, the margin of safety is large. But, say, as new assets roll in over time, your top 10 positions have moved up. Then adding to these positions lowers the margin of safety, and adding a new position dilutes the portfolio concentration. You have managed such a portfolio very well. Can you give us your thoughts on this topic?
I recently heard you say that you believe that MasterCard (MA) has the potential to be a 5-10x bagger over the next decade. Can you tell us more about your thoughts on MasterCard and why it has the potential to be a multi-bagger?
Can you tell us about another one of your favorite multi-baggers that you held in the past but you do not hold anymore or is now a smaller position? Why did you decide to lower the position size (or eliminate the position)?
Lastly, can you tell us about one of your larger positions in the past that did not work out as expected? What went wrong?
[Akre] You have hit on a very important issue which affects all portfolio managers, and that is how one puts cash to work, especially when valuations are less attractive. And further, you correctly understand that the margin of safety is lower when the valuations are extended. My experience is that I have tried several methods, a) allocating funds across the portfolio, b) placing funds in only the top few that are cheapest, and c) holding cash for extended periods. The results…They have all had their pluses and failures. One simply has to continue to look for the characteristics which attract them and strike when they are attractively priced. It certainly distorts the relative concentrations in the portfolio, but that is the outcome of a dynamic portfolio.
Re: MA. I do not recall saying that MA was a potential 5 or 10 bagger; however, I do believe that is possible. Examine the net margins of both V and MA and dream a little. So the key then is reinvestment. It will be very hard to find things to spend their money on that have the types of returns that they already developed internally!
See question #4.
12. Teenage clothing is a tough business. Significant market shares are gained and lost based on merchandising decisions. How did Aeropostale fit the "three-legged stool" model of Akre Funds? Can you tell us more what attracted you to this business?
[Akre] We believe the shares are remarkably cheap. The company has no debt and a very long history of success in the preteen and teenage. They will either get the current issue straightened out or they won’t. If they do not, I believe we are well protected in our purchase price, and if they get it right, we will be well rewarded.
13. Hi Chuck, I am just beginning to know about your new fund and your positions and the three-legged stool in investing. I would appreciate to know more about it.
1) How you can define the integrity and capability of management by reading their writing and watching their actions? Do you often talk to them or use a scuttle-butt approach (like Phil Fisher)?
2) How do you decide that the company has reinvested the excess cash profitably with high return?
3) For the famous position of your fund in American Tower (AMT), I have scanned their performance over the last 10 years using Morningstar. Their return on equity is not high, the long-term debt level is nearly double the amount of equity, and now the free cash flow stays at $670 million. It definitely is not very attractive at the first look. How do you calculate the return on owner's capital for AMT? And with this price valuing the company at $21 billion, is that too expensive? What's the calculation to determine it?
[Akre] First question. Investing is about gathering data points (good MBA word) and digesting them in your own neural network. If you have prepared yourself well, then the outcome (your judgment) will be useful. Charlie and Warren are always talking about lifetime learning. This is what I mean by preparing yourself well. So, after a while, you begin to recognize aspects of human behavior which you’ve seen before. You learn to pick it up from conversations, speeches, writings, etc.
Second question. It is an outcome from simple observation. You can do either a precise calculation, or an approximate calculation based on the information the company supplies.
Third question. Re: AMT — the incremental returns on capital are off the charts at AMT. For example once beyond 2.1 tenants per tower, the returns on incremental capital are in the 90% range. Second, we have actually had a change in management at AMT, where the founder, Steve Dodge, and at least two CFOs have moved on to other opportunities. The business is so good that it has prospered under new leadership. The current chairman and CEO, Jim Taiclet, is world class. Third, their reinvestment has been a mix of adding new towers, both greenfield and by acquisition, and the balance has been used to strengthen their balance sheet, and then pursue share repurchases. The net result has been a growth in economic value per share which we calculate to be a mid- to upper-teens rate since 2002. The proof is in the growth in the business’ cash flow, tower count, etc. Its current valuation is at the top end of our appetite, and the company is in our mind one of the best business models extant today.
14. I know that you are a "bottom-up" investor, but do you think that there are any companies that you would look at more closely due to the "baby boomers" shifting their money into retirement accounts or spending their money?
[Akre] The investment management business is one of the best businesses to own.
15. Quite impressed with your approach to investing where you look at growth and value both. My questions are:
1) How does a retail investor conduct the kinds of research you do in terms of talking to management, suppliers, competitors etc.?
2) If you have a business that historically generated high returns on invested capital and is available for a reasonable or cheap price, but the management has made some expensive acquisitions in the recent past and its re-investment efforts have either failed to produce results or the management appears clueless about this, would you pass on such a company? What would you recommend to management of such a company? Buy back shares like crazy? Pay out 75% of FCF in the form of cash dividends? I am sure you can guess many names that fit this description.
3) What kind of moat, pricing power, competitive edge do you see in the discount retailers in your portfolios like Ross Stores Inc. (ROST), TJX Companies (TJX) and Aeropostale (ARO)?
4) Coming to American Tower, which has been a multi-bagger for you, does valuation come into the picture in terms of selling... or as long as you see the growth and re-investment opportunities, you are a patient share holder?
5) Why did you sell Ensco Plc. (ESV)?
[Akre] Question one. It may be a little more difficult for an ordinary investor to get access to all the things you mention, but the financial filings are always going to get you most of the way home. You also certainly have the opportunity to check with suppliers, etc., just as a so called professional would.
Second question. We are always trying to understand how the management thinks about the reinvestment issue. We will make observations, and occasionally unsolicited suggestions. But human behavior comes into play, and if they just don’t “get it” we move on, or reclassify the opportunity.
Third question. The moat for the discount retailers you mention is shallow and narrow, and in our mind consists of a rock-solid balance sheet, and a well-developed merchandising skill.
Fourth question. See Q #13 above.
16. Can you tell us how you get comfortable with Lamar's huge indebtedness of 5x Debt/EBITDA? As management is reviving back its capex to 100 million, it seems unlikely that paying down debt is a high priority going forward.
The long-term opportunity from digital billboards is huge — only 1,200 off the 146,000 billboards are digital today. Lamar can easily get to 5% or 7,300 of these boards being digital over the next few years. That is about 6x. The economics of digital are amazing with about 10x higher revenue, break-even in less than a year, and very high incremental EBITDA margin relative to traditional billboards. So, when the local advertising markets recover, they will be ready. My question is — is this similar to your take on Lamar? And if so, what is Mr. Market missing here?
[Akre] Re LAMR.The business can easily support a leveraged balance sheet. The management has in the past chosen to leverage up the business through a share buyback and a special dividend. In hindsight, it was a poor decision, as they nearly broke a bank covenant in 2008, and the refinancing to remedy was (is) very costly. But the facts remain that it is a wide moat business; advertising spending in the US is growing again (albeit better in the national than local markets), the digital opportunity is very attractive, and the shares are modestly valued by the market. I suspect that the market is reacting to two things at least. One, that the management has a spotty record on reinvestment, and two, that the “local” market is lagging the national ad market in recovery. Also see answer #1.