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On May 16, 2017, we held a conference call with David Marcus, CEO and chief investment officer of Evermore Global Advisors. Marcus's investment career started in the late 1980s at Mutual Series, where he worked with the renowned value investor Michael Price, whose investment process and stock-picking abilities we held in very high regard. Since leaving Mutual Series, Marcus has had wide-ranging experiences starting a long-short hedge fund; operating and restructuring some of the private and public businesses under the control of the European-based Stenbeck family; investing in small- to mid-cap special situations; and utilizing an activist, private-equity approach. In 2009, he founded Evermore and launched a long-biased global mutual fund, Evermore Global Value (EVGIX), which we recommend in the Global stock category.
In the course of getting to know him over the past several years, we've gained a high level of confidence in Marcus as an investor and in his investment approach. This is due in large part to the unique brand of value investing we believe he learned from Michael Price many years ago and still practices today. We excerpted portions of our discussion in a question and answer format to present his views in as much depth as possible.
David, you and your team employ a bottom-up approach and invest in misunderstood and under-researched companies where there appears to be a large disconnect between price and intrinsic value and where catalysts exist to close these gaps. How do you generate these ideas?
We take what I think is a differentiated approach. We don't screen for ideas using numbers. We think that's the way a lot of investors do it. We focus on keywords.
We start by looking for companies that are going through strategic change. At the core of everything that I do, it's cheap stocks, but we insist on catalysts. So we're searching for keywords like post-reorganization equity, bankruptcy, spinoff, breakup. We're looking for companies that may announce at their annual meeting or some event that they're reviewing all their operations and may spin off non-core assets. We want to figure out what the non-core assets are.
Once they say that, they really don't publish much more information. We get an alert. We have a variety of services that we're using to track keywords and search continuously for them. We get the alert and then we just do our work. We'll go into a whole process of vetting an idea.
The keywords are the first and foremost place that we start. The other place is the network. I think we have one of the best networks of individuals and families that control businesses all over the world, and especially in Europe. Investment bankers that we've gotten to know over the years. They understand that we're not just looking for cheap stocks. We have to have catalysts. We love family-controlled businesses that are going through strategic change.
These are the areas we start to look for ideas. But it starts with the keywords. Looking for not just cheap, but something that's changing. The key is to get the value out of the stock and into the shareholders' hands.
Once you generate these ideas, what business or industry analysis do you perform?
Well, we're doing a whole host of different tests and analysis.
For example, we own a company in Spain called Indra Sistemos. Indra is a newer addition to the portfolio. This is a business that's in IT, but it's also defense. It's transportation. It's media services. It's a whole host of areas.
The bottom line is that Indra has been a turnaround story for a number of years and was somewhat undermanaged. The impetus for us was management change. That's one of the things that we focus on. But we start with the first question: Is it cheap? Once we conclude it is, then we want to go to understanding why it's cheap and what would make it less cheap.
To do that, we can't just look at the company itself. We also have to understand the industry. We look at the competitive environment. Who do they compete with? Who are their best players? We benchmark them against the best players in their industry, not just in their country, but really across the whole industry globally.
We look at why they may or may not be gaining customers. We'll try to talk to some of the customers. In the case of Indra, we've found a company that had a wonderful basic business in a whole host of industries, and they were delivering very mediocre returns to shareholders.
That's what we hate: promises of "tomorrow" returns, where there's a tomorrow story. Our test was how would this ever become a "today" story.
Well, we knew the management because of its prior existence at other companies and had gotten to know them well. So we knew this was a high-caliber management team. When we see an A-quality manager/CEO coming to a previously C-managed company, we can generally expect to see more compelling change going on.
The key is that we're not just betting on companies. We're betting on people. It's critical to marry the two, to understand not just what is the business, but who is running the business. What are his or her goals? Do they have the background, skillset, and knowledge to actually deliver real returns?
In the case of Indra, we're sort of in the midst of a change, right now. They're selling non-core assets. They've made an acquisition of a competitor to beef up their offering. They've done a headcount reduction, because frankly they're loaded with people who are As, Bs, and Cs, and they're focusing on their As.
So you slowly see that come through their results. It takes time. We generally understand that it will take quite some time for our stocks to work. But we're looking for stocks that are compelling. They trade at huge discounts and can crank out significant rates of return over time.
How important is your expectation of future earnings and cash flow growth when assessing the intrinsic value of a business?
We're not a big believer in doing discounted cash flow analysis. I think that those kinds of tests are frankly a complete waste of time. They can generate any answer you want them to generate. It's great to forecast five years out. We see that most managers could barely generate one-year forecasts or two-year. They're really not even close to being in the area of being reasonable.
What we're actually looking for are companies that we're comfortable with: What are the assets we have today? What's the nature of the business today? How is it evolving?
[For example, if] industry margins are 12%; these guys are at 6%. Let's forget that they'll ever get to 12%. Can they get to 8%? Can they get to 9%? How hard is it to get to those levels? And what does that mean?
So we do a restructuring analysis of the business to see on their way to industry-normal or competitively normal margins, how much value can that deliver to the bottom line? Is it even possible? Then, how long will it take?
So what do they have today? What did they have yesterday? What is it worth currently? If they can tweak it enough with real plans and goals, how will that impact the existing business?
Meaning, we don't make forecasts of huge revenue increases or anything like that. If we just assume the revenues are about the same and they can fix the things that are broken, if that then becomes a cheap stock, guess what? The future is a bonus. We get all that growth for free. Or better yet, we're getting paid to take it because we get it at a discount.
A lot of people think value investors don't like growth. That's not true. We just don't like to pay for growth. We want to get things cheap. We want to get it and pay nothing or get paid to take it. I think the case with Indra is a perfect example.
Could you elaborate on your thesis on Indra?
This company had an operating margin that was really, I would say, in the low 5% to 6% range, whereas the competitors were actually more than double that.
We tried to understand in conversations with the company and other companies in the industry what's going on here. Is this a business worthy of our time?
The attraction is the cheap valuation plus this high-caliber new management. But we need to know there's a plan behind it. In our due diligence—our vetting process—we realized that this is a company that was just laden with old contracts.
If you have a three-, five-, or eight-year contract to provide services, but the predecessor management locked in very low margins, the company's locked into this. But we saw that the contracts were starting to roll over and we were witnessing real discipline. Meaning, management was saying to the customer: If you don't pay us a fair price, which was X or X-plus relative to what you were paying us, guess what? We'd refer you to our competition. You can hurt them. You're not going to hurt us.
So, when we see that kind of discipline coming in, it's one thing for managers to say they're going to walk away from business. It's another thing to actually see them do it.
They started to walk away from bad contracts. They started to negotiate better contracts. We could see it in the process and see it in the publicly released announcements from the company, as they were winning huge contracts. You could see these were higher-caliber government contracts.
We didn't just go out and buy it because it was cheap. We spent a lot of time getting to know them. We went to Madrid and met with management a couple of times before we actually ever even pulled the trigger. We like to get to know who we're betting with.
Then while we were working on Indra, they launched a tender offer for a competitor. A company called Tecnocom. Well, Tecnocom brought a doubling of Indra’s Spanish business. So we thought this was quite interesting, because in a low-growth environment the ability to buy growth at a cheap price is good.
So they bought this competitor. But at the same time, the competitor had higher margins. What we liked about the CEO was his view was, we only want best practices. If they [Tecnocom] have a better process for managing the contracts, we'd adopt theirs instead of ours.
They went to the best process across the two companies. It's still early innings, but our conclusion was the pieces are in place. The early signs are positive. The market's expectations are always too high with turnarounds, and they're almost always wrong. We don't care what the market thinks. We care about what we think and what our analysis shows it's really worth in the long run.
If these opportunities come through, I think investors will be pleasantly surprised. We see it all the time. All of a sudden you wake up and say: Oh, the company really did change.
Most investors want to come into these transformation stories after the breakup, after the spinoff, after the restructuring. It's too expensive at that point. We want to get involved when it's in the midst of a change. That's when it's the cheapest and it's the most compelling. Because earnings are the least component instead of the most. We have so many other things that are going on as well.
It obviously follows that, compared to other investors, you're going in early. You're also taking on more execution risk. That's where your assessment of management becomes key. Could you talk about your experience and what makes you confident you will get what you expect from management?
We look at their background. Their history. What they've done before.
When you get outside of the U.S., you have a lot of companies that still have a family or individual that might still dominate the company. We want to know who are they. We go way far back.
They throw their pitch book on our desk; we don't care about it. We've already read it. We ask them who are they. What's your background? What's your history? Why are they here? Are you only there because your dad was the chairman and put the kid in? Or are they real value creators?
We're vetting. We're triangulating. We use our network to help triangulate and vet. Not numbers, but industries, sectors, and people that are running companies. This process is very laborious and time consuming. It's critical. You [Litman Gregory] have been talking to us for years, getting to know us. We do that, too.
You go back and ask the same manager the same questions six months later. If you get different answers about how they think about creating value, that's not a good thing. They don't always remember they met you. We like it that way.
Where did they used to work? Talking to people there. Really vetting it out. When we finally hit the go-button to get involved, it's really because we've put it through the gamut and we're very highly confident.
We're not going to get it right in every case, of course not. I don't want to go too far off on a tangent here, but I'll say this: In this age of information overload, where there's so much information at our fingertips, what we've seen is that a lot of people don't take advantage of it. [There's] so much information people don't look at it.
What's happening in the trade rags? We're reading all kinds of industry trade journals that have really good information on companies. It just may be that one of their divisions made an announcement that's compelling but it didn't bubble up to the Financial Times or the Wall Street Journal. But it's really important. So these alerts that we set up help search trade journals, as well. It's just absolutely invaluable how much information there is.
I'll print out 15 years of the letter from the chairman or the CEO or whoever wrote a letter or annual report and not even look at the numbers. I'll turn this pile upside down and just read through it from the back to the front. It's like a movie. Sometimes it's a good movie and sometimes it's a bad movie.
You get the whole story of the company. Because a lot of the things that they talked about three years ago, four years ago, five years ago that are costing the company real money, they stopped talking about it. Or things that are bubbling up that are very positive, you see them just coming through in the discussion and what they're talking about. So it's very helpful to get that.
When they come to our office or we go to their office, we can say: Hey, eight years ago, you spent $500 million on XYZ. Now you don't talk about it. Now, sometimes it's even better or sometimes it's worse, but we hold them accountable—not for what we expect of them, but for the expectations they set.
They're talking about their three- to five-year forecasts. Margins. Returns on capital. Whatever it is. I've been in situations where I say: Hold on a minute. Before we talk about that, I just happen to have with me your pitch book from three years ago when you did a three-year forecast. Let's see how good you were. Of course, we've already read it and we already know the answer. We're not trying to do a "gotcha" style of investing. It's just that we want to have a situation where you're holding them accountable for what they said they would do.
When we find the ones that really deliver and that the market hasn't rewarded with a compelling valuation, it sometimes might be the simplest thing of all. If you have the good set of businesses that are 90% of your company and you have 10% that are not good, the market will always value you at your weakest business. We see these companies that are in the process of getting rid of the 10% that isn't good. When that happens, the market revalues them so dramatically. That's the bet we're making—this transition.
As I say, a lot of investors want to come in way after it's done. That's generally when we believe those companies may be too good for us. They're high-multiple growth businesses that are contingent on one thing: growing earnings. That's the last thing that we're interested in.
You say you won't buy a company no matter how cheap if you do not see a catalyst. What does catalyst mean to you? And why do you want to see that prior to a purchase?
In my view, I distill [value investing] down to two camps. There's the guy that wants to buy a dollar for $0.50 and doesn't care about catalysts because he believes that over time, the market will figure it out or the stock will revert to the mean. Nothing wrong with that. I just have no interest in that camp.
Because in that camp can also be what we call "value traps." So a fifty-cent dollar where the dollar keeps eroding, it's always fifty cents on the dollar. So you're just constantly losing money. It always looks cheap and you never make money. Actually, you're losing money. I'm not interested.
I want to be in the camp where I know that I have these catalysts. They could be, as I said before, a breakup. They're selling non-core assets. They're spinning off businesses that no longer fit. They had a diamond in the middle, but it was surrounded by coal. They get rid of the coal and see all these diamonds in the middle—that's what we're talking about.
So these operational fixes are fantastic. Financial restructuring. Maybe they had a high cost of debt. Well, because they've improved the business, they now can get low-cost debt. That saves millions of dollars per quarter, per year.
The whole point is, rather than focusing on activists who are attacking companies, I like it when I can find a company that's led by an activist. I don't mean an activist that's attacking it. I mean from the inside out, management is focused on creating value. It's tired of making excuses. They're shedding their non-core businesses and refocusing on the good businesses. They're buying back stock.
You mention Europe. You've been talking about competitive opportunities in Europe for a while. You just mentioned, historically, Europe could not do a lot of the things they're able to do now. Could you just elaborate on that a little bit more?
First of all, I've been investing in Europe now for I think over 25 years. Back in the olden days when I started—in the early '90s—the first country I ever went to was Sweden. They'd gone through a banking crisis. The banks were bust. The government was bailing them out. It was the first country I went to, and I found there was nothing but opportunity. Because in a crisis, everybody goes home. The foreign investors really went back to their countries. Everybody goes home in a crisis. They want the comfort of home. For me, the last place I want to be in a crisis is at home. I want to go somewhere else.
Sweden was great in the early '90s. The value investments and catalysts were absolute homeruns. That was when I worked for Michael Price. If you fast-forward to today, some of those companies, some of those banks in Sweden, today are the strongest. Not just in Europe, but on earth. They're very well capitalized and great businesses.
Now you look at the rest of Europe. This crisis is deep and wide. It has been at least over the years. The financial crisis really exposed a lot of problems structurally in Europe.
What we've seen is that it's not that the governments want to bail out companies. I can tell you that's not the case in Europe, for sure. But the governments have realized that if they didn't change rules and regulations, instead of x number of people out of a job, you'd have 3x. So they changed the rules. The companies can now close factories, shut down facilities, consolidate operations. If they can't, you have companies that are saying, Well, if we can't, we'll just move production anyway.
The companies have more gumption than they ever had before. Because there's pressure from shareholders on boards. There's pressure from boards on managers. Europe is a robust environment of change.
Lately things have been turning the corner in Europe. Some stocks there have gone up a lot. How compelling is the opportunity in Europe still, in your mind?
We're not macro guys. We're not top-down. But I just read something where I think the GDP expectations for Europe are now higher than in the U.S., this year and next. Again, that's not how we focus.
But we're looking at the companies from the bottom up. So if you get the environment being a little more conducive, that's unbelievably powerful to the earnings of these companies. We're not counting on it.
We build our models with no growth. No high expectations of a pick-up. And if we find things that are cheap without any of that, then if you get a little topline growth, you get absolutely explosive earnings. Because they've cut costs. The margins are higher, and with really just modest revenue increases, you see an explosion.
We're not investing in Europe as much as we're investing in companies that are based in Europe. A lot of these businesses are global and multinational. They happen to be in Germany or Sweden or Spain. That makes it a cheaper play. And that's what's working.
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