Andvari 2017Q4 Letter

Click here to read Andvari’s 2017q4 letter in pdf form. Otherwise, please read on…

Dear Friends,

Instead of beginning with a summary of investment performance, I begin with even more important news. As many of you know, my wife Leann has cystic fibrosis, a rare and life-threatening genetic disease that affects the lungs and digestive system. After being in the hospital six times in 2017, Leann and I traveled to Duke University so she could be evaluated for a double lung transplant. It was an exhausting five days of tests and meeting with everyone on Duke’s transplant team. Duke later told Leann she is a good candidate for their program and Leann decided to join.

Leann’s decision means she and I will be temporarily relocating to Durham at the end of January. Depending on how well Leann does, we could be in Durham for four months or up to a year. As the Chief Investment Officer and sole employee of Andvari Associates, it is important for all clients to know that in the coming months most of my time will be spent caring for Leann—not our investment portfolios.

With that said, I have reassured clients with the following points.

First, my investment strategy is to have a limited number of securities in portfolios—20 or less—and to have the top 5 make up a significant portion of each portfolio. This makes it easier and more efficient to keep up with what we own and to consider new opportunities.

Second, I prefer to invest in securities and companies that do not require daily attention. Good companies with good management teams have higher chances of earning strong returns over a long time despite any short-term difficulties that inevitably happen. However, I do and will still review everything we own, every day, and will be prepared to act as circumstances dictate.

Third, I am invested in nearly all the same securities in which clients are invested. This is a huge incentive for me to maximize gains and minimize losses. Balancing my time between caring for Leann post-transplant and caring for clients will be a challenge, but it is one I can handle.

Finally, I will not be alone in caring for Leann. When the time comes for transplant, Leann’s parents will be with us in Durham to help. Leann’s father is Executive Director of the Georgia Chapter of the Cystic Fibrosis Foundation and his employer expects him to be there.

Please keep us in your thoughts this year.


For the full year of 2017, Andvari is up 18.9% net of fees versus 21.8% for the S&P 500. Focusing on the performance of just the taxable accounts Andvari manages that have a mandate for achieving maximum total returns over the long term, these accounts were up 25.0% net of fees. Below, the table shows Andvari’s composite performance figures against three benchmarks while the chart shows the cumulative gains of a hypothetical $100 investment.


Although Andvari had a sizeable lead over the S&P 500 at the end of September, performance during the last quarter of the year lagged the market by roughly 8 percentage points and caused Andvari to underperform the market for the year. Large declines in our top positions—Mesa Labs (MLAB) and Liberty Broadband (LBRDA)—are the main culprits.

Mesa’s share price declined because recent results in two of their segments were surprisingly bad. First, in their Instruments segment, Mesa had discontinued an old product and rolled out a replacement, but adoption of the new product was slower than expected. Second, the company’s Cold Chain Packaging segment struggled from lower order rates and a delayed order from a very large customer. Mesa even stated in its regulatory filing that the company might take an impairment charge on this segment. Mesa’s share price fell from $158 per share to $125 over four days.

Despite Mesa’s poor results, I’m confident the company will fix the issues facing these two segments. My trip to Mesa’s shareholder meeting in early November is the reason for my confidence. All the employees I met were nice, happy, and enthusiastic about having Gary Owens on board as their new CEO. Also, everyone confirmed the company is embarking on the creation of a continuous improvement culture. This was music to my ears, given that Gary had spent 10 years of his career at Danaher, a company that has produced amazing shareholder returns with the help of its own continuous improvement system and culture. Although it could be a few years before shareholders see benefits from Gary’s efforts, I am excited about the opportunity to unlock Mesa’s full potential.

The other negative contributor to performance was the decline in Liberty Broadband’s price. This was likely because of Charter Communications (Liberty Broadband’s largest holding) losing video subscribers in the recent quarter and the decreased likelihood that Charter might be acquired in the short-term. The mitigating factor to these short-term concerns is that Charter still has much to do in terms of integrating its acquisition of Time Warner Cable and Brighthouse. One task is the harmonization and simplification of the various packages the entire company offers to customers. Some customers will inevitably leave during this process and some customers will continue to “cut the cord” and prefer an internet-only offering rather than an offering contains video. However, even if customers continue to cut the cord in favor of the internet, the margins on broadband are much greater than video. Charter will still be able to grow operating profits at a good clip even if revenue growth is less than what the market expected.


Sientra was one of our best performers during the year—up 65%—for two reasons. First, it acquired Miramar, a company with a promising device that reduces underarm sweat and odor and permanently reduces hair. This acquisition was a signal to the market that Sientra is serious about becoming a more diversified medical aesthetics company.

Second, Sientra continued to execute on its business plan. The company sold its remaining inventory in a controlled fashion throughout the year. At the same time, Sientra diligently prepared for FDA inspection of the production facilities of its new manufacturer. Although the FDA completed its inspection later than Sientra had wanted, the company is extremely confident the FDA will grant pre-market approval for its newly manufactured breast implants in the first quarter of 2018. If Sientra is finally able to make and sell new implants, and with several new products in the arsenals of its sales reps, 2018 could be another banner year.

Micro Focus was also a solid contributor to 2017 performance with a gain of 21% (including dividends). The company has been extremely busy as it prepared for and completed the acquisition of HPE’s software business in September. Upon completion of that transaction, Micro Focus tripled in size and has an extraordinary opportunity to double the margins on HPE’s software business. Another important result of this transaction is that Micro Focus now has shares that trade in the U.S. as American Depository Receipts—Andvari was finally able to add Micro Focus to the retirement accounts we manage.

Shares remain undervalued as many investors are still unfamiliar with Micro Focus even though it’s now the 7th largest pure-play software company in the world. Many new and potential Micro Focus shareholders may also be turned off by the company’s operating model of operating as efficiently as possible a portfolio of low growth software assets. Over the long run, sales growth will be in the low single-digits, but there will occasionally be a year or two where sales growth will be negative: Micro Focus management expects sales growth for the upcoming year to be down 2%–4%.

When an analyst asked Micro Focus management what’s gone wrong with sales growth, Executive Chairman Kevin Loosemore responded:

“The [question of] ‘What’s going wrong?’ is based on an assumption that revenue growth is a good thing in a business. It is if that’s the right thing for the business. If it’s the wrong thing for the business, chasing revenue growth is actually damaging to shareholders.”

Micro Focus, unlike most other software companies, is extraordinarily focused on their internal operations and uses continuous improvement concepts to produce great value for their customers and great returns for their shareholders. This sometimes means their best opportunity is to reduce expenses rather than waste valuable resources trying to grow an asset that is incapable of high growth. In a world where growth is the goal and natural progression, many investors have a psychologically difficult time with companies that choose to voluntarily shrink their business. As such, they will sell their shares at the first sign of “poor” guidance or will not even consider becoming a Micro Focus shareholder in the first place. Andvari, on the other hand, accepts and endorses Micro Focus’ unique strategy and we are happy to endure a journey likely to be bumpy in exchange for robust shareholder results over the long-term.


Despite not owning any of the largest and best performing companies in the S&P 500 (like Google, Facebook, or Amazon) and despite having a meaningful allocation to fixed income assets because of the IRA accounts we manage, Andvari’s net performance for 2017 of 18.9% was quite good on a relative and absolute basis. With the U.S. economy chugging along and with increasing levels of optimism, it seems like 2018 might be another good year for investment performance. However, I continue to caution that investment returns over the next 5 years are unlikely to match what we have experienced in the prior 5 years.

I am extremely thankful for the trust, understanding, and encouragement I’ve received from all clients over the years and especially as we head into 2018. I wish everyone a happy and prosperous year.


Douglas E. Ott, II



¹ “Andvari Total” represents all of Douglas Ott’s investment accounts and all the discretionary accounts Andvari manages where it takes an active role in picking individual stocks and receives a fee. From 12/31/12 to 4/12/13 results included only Ott’s personal and retirement accounts—the first Andvari clients transferred their accounts on 4/12/13. Andvari believes including Ott’s performance figures for the first 4 months of 2013 is fair as he managed those assets similarly relative to later clients. Results are net of management fees (1% per annum), time-weighted, and includes all cash and other securities. The indexes and funds are listed as benchmarks and are total return figures and assumes dividends are reinvested and net of their respective underlying fees.

Andvari Idea Wins Category in “Top Stocks for 2017” Contest

Last December I submitted a research report on the British software company Micro Focus—a holding of Andvari clients since late 2015—to SumZero’s “Top Stocks for 2017” contest. Given the company’s recent transformational deal to acquire Hewlett Packard Enterprise’s software division, the contest was the perfect opportunity to update my research and present the Micro Focus investment case to an esteemed community of colleagues.

There were five categories in the contest that would each have one winner and two runners-up. A panel of 27 judges, ranging from senior managers at hedge funds to representatives of multi-billion-dollar endowment funds, independently reviewed and voted on over 150 submissions. Four criteria were used to select the winners and runners-up:

  • Validity of the Thesis;
  • Strength of the Supporting Argument;
  • Feasibility of the Trade; and
  • Originality.

I am extremely happy that my report was chosen as the winner for the “Mid/Large Cap” category! It is truly special when a group of highly-accomplished fellow professionals recognizes the quality of your work.

I am also proud to have been a member of SumZero since 2010. SumZero is the world’s largest community of investment professionals working at hedge funds, mutual funds, and private equity funds. With more than 12,000 pre-screened professionals collaborating on a fully-transparent platform, SumZero has fostered the sharing of many thousands of proprietary investment reports.

The Amazing Capital Cities Roll-Up

With change accelerating in the media/telecom world seeming to accelerate in the past few years, I finally got around to reading Walt Hawyer’s history of Capital Cities (I read the paperback edition and through this post I will reference the page numbers in case you have the book and want to follow along). I was already a little bit familiar with the company as a result of reading the Berkshire annual reports and knowing that Buffett has always said great things about Tom Murphy and Dan Burke (the two main leaders at Cap Cities following the death of its founder Frank Smith). I then learned a little more about the extent of the phenomenal returns Cap Cities produced for shareholders when I read William Thorndike’s book The Outsiders.

Cap Cities got started when its founder Frank Smith and a group of investors purchased a bankrupt radio station in Albany, New York in 1954. Starting with one radio station, Cap Cities grew and acquired other radio stations, then TV stations, then publications and newspapers, a CATV company, and then the ABC network in 1985.

Hawyer gives the reader an extremely detailed account of (1) the many different people that were key to the success of the company and (2) many of the great challenges and opportunities Capital Cities encountered in its corporate history. It’s a book focused mostly on the people and the individual radio/TV and publishing assets Cap Cities acquired. And there are a lot of people in the book. Towards the end it was getting tedious enough that I was frequently scanning and skipping pages.

The few times he did, it was always very interesting when Hawyer gave details on some of the financials of Cap Cities’ various acquisitions and dispositions—the growth rates and returns for some of their radio and TV station deals were astonishing in some cases.

Given the paltry financial details, I hungered for more and took a two-pronged approach to learning more in this area. First, I would pick one deal in the book that had sufficient financial details that would allow me to do some guesstimation and come up with rough/approximate IRR figure. This one deal was the acquisition of KTRK-TV in 1967. Second, I would do some googling for any historical financials or annual reports for Capital Cities. Given that I have no access to any databases for historical financials, I wasn’t expecting to find much or anything at all, so I started with the thought experiment.

Guesstimating the KTRK Deal IRR

Below are the key details I used to guesstimate historical pre-tax income for the station and thus a rough IRR:

  • TV station based in Houston, Texas and 3rd place in ratings (pg. 93)
  • Station’s investors only making “some money” by 1966 (pg. 94)
  • KTRK ownership was highly splintered: 11 of the original investors were dead and their stock was in their estates and the two main figures that were still alive could not agree on business matters (pg. 94)
  • Acquired in 1967 for $22.5 million: $4 million came from cash and the other $18.5 million from trading away their WPRO-TV station (pg. 92)
  • Started to pay off dramatically by the early 1970s when pre-tax profits exceeded $22.5 million each year until 1985 when Texas economy crashed (pg. 93)
  • In 1984, pre-tax profit was more than 2x what Murphy paid for the station (pg. 93)
  • Produced several hundred million in pre-tax profits for Cap Cities (pg. 96)
  • Worth over $300 million in 1994 (pg. 96)

So Cap Cities purchased KTRK for $22.5 million. At the time, Houston had a population of about 700,000 and KTRK was third place in terms of ratings. Cap Cities quickly cut expenses, improved sales and profitability, and kept the ball rolling until the station was valued at over $300 million in 1994 according to the author. Not accounting for leverage, my best guess for the after-tax IRR of this purchase was in the low 30% range. Again, the table below is based purely on my best estimates for this particular station given the clues from the book, they are not real numbers.

KTRK-TV Guesstimated Pre-Tax Income and IRR


It’s also important to consider the other options Cap Cities had with its money at the time. Towards the end of 1967 when Cap Cities purchased KTRK, the U.S. ten year note was at about 5.7% after increasing steadily from WWII lows and the S&P earnings yield was about 5.5%–5.6%. So let’s say Cap Cities had a goal of getting low to mid-teens returns on their capital at that time, or roughly 2.5x the yield on a ten-year note. Assuming KTRK had $2.0 million of pre-tax income and $1.2 million of net income, Cap Cities purchased the station at a 18.75x net income multiple or a 5.3% yield. Without knowing anymore details beyond that, you’d think Cap Cities may have been kinda dumb: why buy something risky that yielded less than a T-note? Or, since we can only guess at the details, maybe the station was earning a little more money than my guesstimate and Cap Cities paid a lower multiple simply because the original investors wanted out?

Anyways, whatever the actual numbers were, there is no doubt the KTRK purchase was super cheap given the enormous growth prospects! Cap Cities could have paid $60 million for KTRK at a 66.7x earnings multiple or a paltry 1.5% earnings yield and they still would have gotten a high-teens IRR based on my guesstimates in the chart above! And just think if they had used even a little bit of leverage. This illustration just goes to show how important growth can be when it comes to returns and valuation.

This was probably a time where even an average operator could succeed. Purchasing a station in a market that had a high likelihood of above average growth at even an above-average multiple seems like it would have produced good returns for an investor. Getting into a city like Houston when population growth goes gangbusters will obviously do wonders for returns. If you own a radio or TV station in a city growing 30%–60% decade over decade versus the national average of 10%–20%, you’re gonna do just fine.


But picking the right growth markets doesn’t fully explain Cap Cities success. The Cap Cities crew really kicked their returns into overdrive by just being flat-out the best operators and managers.

One of the big reasons Cap Cities was so successful was they had a management culture that could easily cut unnecessary expense while simultaneously investing new equipment or sales reps when they were necessary. You could say this culture really was branded on them by their original circumstances in purchasing a bankrupt station housed in a former convent for nuns. The original, barebones staff was hired purely based on what Smith and his investors could afford (which was not much). Employees had multiple jobs and responsibilities and had to make do without financial resources. In the 14 months after Smith purchased his first radio station, they were over $700,000 in the red. However, with good programming and a focus on keeping expenses low and investing in sales growth, the station came to be profitable and Smith started looking to acquire a second station. And the rest is history as they say.

Throughout Cap Cities’ history, Smith and Murphy frequently acquired assets that were underperforming in some fashion and then worked on turning them around. A radio station may have had too many employees, its ad rates may have been too low, or it hadn’t invested enough into hiring good salesmen. One of the lessons Murphy learned from Smith was “to look for properties that previous management had failed to develop to their fullest potential” (pg. 95).

Does this sound at all like other people and companies in 2015? Valeant, 3G, Transdigm, Danaher? Cap Cities may have been one of the earlier companies that could have been described as “lean” or taking a zero-based budgeting approach. This is even even more impressive given they were in the media business, which typically has not been known for great cost controls.

Corrupting With Autonomy and Authority

This gets to the second big reason why Cap Cities did so well. Cap Cities executives hired good managers and took a hands-off approach with them. As long as managers were growing sales and cutting costs, Tom Murphy and Dan Burke did not have to give marching orders or micro-manage: “Once Capital Cities taught them how to run a business, they let them run it with virtually no interference.”

Dan Burke recalled some comments Smith once made on the subject of autonomy:

Smitty said to me, “Some of you fellows may think I tie you to Capital Cities by corrupting you with compensation and stock options. … But I’ve decided the reason you’re scared to leave is because the system we have corrupts you with autonomy and authority. And I suspect that after you live that way, you’re very fearful that someplace else wouldn’t be the same” (pg. 89).

Furthermore, Hawyer wrote:

“Over the next two decades leading up to the ABC merger in 1986, Murphy would borrow religiously from the Smith formula: An unpretentious, decentralized management style that gave his executives authority and responsibility to run their operations without heavy-handed interference from the top” (pg. 91).


This combination of bare-bones SG&A expenditures—concurrent with investing/spending money only when it was necessary—and a hands-off management style are what produced 70% pre-tax margins for Cap Cities TV stations versus the industry average of 34% according to this Fortune article!

Here are two charts from Robert Hagstrom’s first edition of The Warren Buffett Way showing Cap Cities margins and returns on equity:

Cap Cities Pre-Tax Margins


Cap Cities Returns on Equity


Again, what a company!

A More Complete Picture

Moving from a case study of a single transaction, let’s look at Cap Cities as a whole. Throughout its history, Smith and Murphy continually bought and sold assets. Given the FCC rules and restrictions regarding ownership of media assets, there was really no other way to grow at the pace they wanted to grow. They rolled up assets, selling them in order to trade up for a different asset with a bigger opportunity, frequently using a generous amount of debt. Had there not been FCC restrictions, Cap Cities probably would have been even more aggressive earlier on, but this is hard to tell as other media owners/investors might also have been more aggressive and thus media assets might have been bid up to sky-high valuations, thus eliminating Cap Cities’ opportunities. But this is just pure speculation…

Anyways, with its acquisitions, Cap Cities could afford to pay what some considered a generous premium because Cap Cities knew how to vastly enhance the sales growth and reduce the operating expenses of the acquired asset. Cap Cities knew how to cut all the costs that weren’t needed while at the same time they were not afraid to spend money on capital upgrades or hiring more salespeople to boost revenues.

The two charts below are from financial data I painstakingly assembled from searching through many issues of Broadcasting Magazine, which has an online archive available to the public. I did my best with this data and make no guarantees as to accuracy. I think these charts nicely sum up Cap Cities’ amazing run from 1958 to 1985, the year it announced it would acquire ABC for $3.5 billion:



Given these figures, the returns for shareholders were amazing. At the end of 1957, Smith offered his first group of employees the chance to purchase Capital Cities shares for a price of $0.71875 per share (pg. 31). The share price would close 1985 at $224.50 per share. Over those 28 years, that’s an annualized return of nearly 23% and this is excluding dividends! (NB, I adjusted these per share figures for the three 2-for-1 splits that would occur between 1957 and 1985, but did not adjust for the 10-for-1 split that would happen in 1994).


I know this post strayed from being a true review of Hawyer’s book and veered mostly into the realm of finance, but I had fun doing this. Even though Hawyer’s book was more about the people than about the deals and financials, it was still extremely illuminating and enlightening. I mean, without all the great people, Cap Cities would not have been nearly as successful! So perhaps I will delve more into the people side in a second post about Cap Cities?

In the end, my takeaway is Cap Cities was indeed one of the most successful roll-ups in corporate history. Thorndike was absolutely correct in his analysis of the company and I bet there is a reason he led off his Outsiders with Cap Cities and Tom Murphy. Cap Cities’ cost-cutting, hands-off management style and willingness to divest/acquire many assets (and their use of debt in the process) is precisely what led to such amazing returns for their shareholders. If you’re able to find a management team of Cap Cities’ caliber in an industry that that can be rolled up, it seems inevitable you will do great, whether its pharma, food, life sciences, or industrials. This is how minnows can eventually swallow whales.


Additional References


How Much Can Charter Save With Greater Scale?

With Charter Communications one of our largest holdings (via Liberty Broadband), I’ve continued to look for reasons why I am wrong about the value of the company. During this ongoing process I’ve come across a few writeups that advocate selling Charter short. The crux of the bull thesis is cable companies in general will be one of the primary beneficiaries of the increasing consumer demand for greater internet speed and capacity as they are better positioned than the traditional telcos. Charter in particular should be able to derive greater benefits as it will be the acquirer of choice to further roll-up the smaller players in the cable industry and thus create a lot of value from synergies and cost savings.

The crux of the bear case is that equity holders will be threatened by a company with a huge amount of debt along with continually large capex spending, tiny margins, and low EBIT and sales growth. Some say synergies will not amount to as much as the bulls think and an unsustainable debt load will turn equity holders into bag holders for a second time.

My subjective, kneejerk reaction to those who suggest Charter should be shorted is that not one of them has put in the time to understand the history of Charter. All of them also seem to have no respect for who John Malone is and what he has done for himself and other shareholders. Why would Malone and Greg Maffei (and several other excellent investors like Jana and Coatue) invest more money into Charter (at prices that are currently higher than shares are now, I would add) if they didn’t expect at least a double-digit return on their money? Malone and/or Maffei have actually said they expect mid-teens returns from this latest investment in Charter. Why would you want to bet against these people?

For the bears who have pointed to huge capex spending and low margins and thus worry about piling on more debt that might be unservicable, they either fail to mention or simply gloss over the fact that Charter has been an undermanaged company for nearly a decade. It’s only in the past few years when Charter hired Ruttledge and emerged from bankruptcy have they been spending meaningfully to replace and upgrade their technology and assets to give customers a better, all-digital experience. Capex will decline and margins will be higher in five years than they are now, especially if/when the deal for TWC and Brighthouse goes through.

Most of the synergies will come through greater scale and bargaining power. For example, programming expenses on the video side for Charter and TWC were 5.7 and 8.1 percentage points higher than for Comcast during 2014. If Charter and TWC could reduce programming expenses to 50% of video revenues, they would save about $530 million. Attach a 10x multiple to that and that’s $5.3 billion of value. Add Brighthouse into the mix, and the savings and value creation could be slightly higher.


And programming expenses is just one pathway to savings. Having greater geographic scale means they will have more efficient advertising and a lower number of technician truck roll-outs. Reducing corporate headcount is another obvious pathway.

In the end, I see no reason why Charter should not be able to approach the size and profitability of Comcast or even surpass Comcast sometime down the road. I still see no reason why I should not own Charter. I still think people saying Charter is a short are kind of crazy.


Notes on 2015 Markel Shareholders’ Meeting

I had the privilege of attending the annual Markel Corporation shareholders’ meeting on May 11, 2015 in Richmond, Virginia. I did my best to take notes of management’s prepared remarks and presentations which I present to you in outline format. The Q&A session is missing because I did not take notes during that time. Following my outline are some of my personal thoughts about what I heard.

  • Alan Kirshner is first to speak
    • Question that most new Markel associates ask him is what keeps him up at night, what worries him the most. He jokes that at his age he worries most about waking up in the morning. But what really does worry him is that Markel starts to believe in its own bull manure. Says that Richie Witt will be talking about what the company has done in the past and what it is presently doing to prevent this from happening and ensure that Markel will last for many more years to come
  • Ann Waleski
    • Speaks about recent and historical financial performance and metrics
    • 13 years of combined ratio < 100% if you exclude the expenses associated with the Alterra acquisition
  • Mike Crowley
    • Says all Markel segments are doing very well but the larger and international lines are facing a challenging price environment
    • Still getting good rates on smaller lines
    • Company has restarted Markel University where they take recent college grads and teach them the insurance business; this is part of perpetuating the Markel culture and the Markel Style
  • Richie Witt
    • This is probably the most interesting part of the evening. Richie gives as quick a recap of the past 7 years as he can, explaining the big initiatives and actions that occurred
    • 2007
      • “Markel 2015” initiative begins; basically talk about what they want Markel to look like in 2015 and how they will get there
        • 10 of the 19 executives at that beginning of this initiative are still with Markel
        • Atlas project starts to accomplish some of the 2015 goals; Atlas was primarily about getting the company onto a single, cohesive system and platform; Richie alludes to the eventual conclusion that it was a mistake to go for one comprehensive system
    • 2008
      • “One Markel” discussion begins; the question is how to change Markel so it can scale for the future
      • Alterra acquisition would have been impossible without the changes came with the One Markel program
    • 2009
      • Mike Crowley joins Markel and brought a huge amount of sales drive and experience to the company
      • Kirshner sets the “5 in 5” goal for the company and management; get to $5 billion in revenues in five years from its $2.1 billion revenue base
        • Main purpose was not growth for the sake of growth, but challenging and changing the mindset of the company. Wanted to show that large growth could be attained without sacrificing profits
    • 2010
      • Creation of Office of Chairman and Office of the President
      • Signals handing off of a lot of management responsibility from previous generation to the next generation
      • First Comp is acquired
      • Course correction at the company when they discontinue Atlas
        • Positive outcome from Atlas was creation of Markel’s data warehouse and wholesale portals
        • Atlas was still an expensive mistake, but it was necessary to allow them to acquire Alterra
    • 2011
      • Branding strategy completed; company now unified under one Markel brand as opposed to a collection of brands for its general market segments
      • Information management system completed
      • Wholesale producer websites finished and online: this was a big homerun for Markel
    • 2012
      • Thomco acquisition
      • Markel’s IT systems are on a good track finally
      • Alterra acquisition in December
        • They went into full integration mode on day one of acquisition which they have not done before; again, the positive changes from Atlas and One Markel enabled quick integration
    • 2013
      • First global business meeting for Markel execs; kind of a boot camp introduction to the Markel Style
        • 43 of the 49 Alterra people at this meeting are still at Markel; shows that people love to work at Markel; also first time lot of Alterra employees felt like they had a permanent home
        • “5 in 5” goal is met with the help of the Alterra acquisition and growth of Markel Ventures
    • 2014
      • Next five year goals established with three categories of goals they have called POPs (Profile, Objectives, Priorities)
      • Profile is all about what kind of company they want to be
      • Objectives were mostly financial in nature
        • Want to double value per share value in five years start from the 12/31/13 figures
        • NAV share from $477 to $954
        • Share price from $580 to $1,160
      • A list of goals
        • Perpetuate the Markel Style
        • Focus on business operations in the same way they have focused on underwriting
        • Make the company highly scalable
        • Grow profits and keep a low combined ratio
        • Develop the Markel environment so they can hire great people
        • Continuous improvement
  • Tom Gayner
    • Tom (always one for humour and a joke) walks from the table on stage to the podium and has a silver briefcase handcuffed to his wrist. He fumbles around for half a minute trying to undo the handcuffs. He announces he is going to share Markel’s “secret strategy” later in his speech
    • Tom says a lot about Markel and how great it is as a company and how great its financial performance has been. Asks rhetorically why Markel is so great and why it will continue…
    • He opens the briefcase and shows us it’s full of nothing. It’s empty. There is no secret strategy that can be contained in that briefcase because the key to Markel’s past and future success are People.
    • Markel is all about hard work and zealous pursuit of excellence and also being a fun place to work
    • Talks about how this unique culture creates a virtuous cycle for every aspect of Markel
    • Tom mentions David Brooks’ book “Road to Character” and how Brooks writes about the difference between résumé values and eulogy values: both are important to Markel
    • Tom talks a little about Markel Ventures
      • Going to have $1 billion in revenues
      • As a whole, Ventures is capital light, meaning the businesses don’t require a lot of capital investments to continue growing
    • Markel is successful because of its people and its culture
  • Steve Markel
    • Says future is “very rosy” for Markel and opens the floor up for questions

Doug’s Thoughts

Although Markel is much larger than it was even just five years ago, the opportunity to grow and create shareholder value remains just as large. Being a larger and more cohesive organization Markel is now able to reap the many benefits that goes with size:

  • It’s easier and less costly to do marketing, advertising, and go after new opportunities;
  • Markel is better able to cross-sell products;
  • It’s easier to maintain and develop customer relationships;
  • Markel has enhanced credibility with the large international insurance brokers;
  • Markel is now the “go-to” insurer in the eyes of brokers and customers for many lines of business;
  • Sourcing and finding investment opportunities gets easier and less expensive;
    • More and more people are coming to Markel to find a permanent home for their business;
    • Although Markel has not started doing this (and maybe never will), they likely have the capability of looking at the financial statements of many of the businesses for which it underwrites insurance policies. It seems like it would be pretty easy to go to a long-time client with a great business and offer to buy them out.

Markel has also started to think in grander terms. Kirshner challenged the management team in 2009 to get to $5 billion in revenues in five years from a base of $2.1 billion. In the past few years, Tom Gayner has talked about wanting to create and be one of the world’s best companies. I think it’s very possible Markel will be able to meet its current goal of doubling value per share from 12/31/13 to 12/31/18. They will probably have to do another good acquisition to make that goal, but they are ready and capable of doing another deal for the right price and the right company.

After the conclusion of the meeting, I was able to speak a little with Alan Kirshner during the reception about building a culture that has allowed Markel to be so successful. He referred to the Jim Collins’ book “Built to Last”. He and the Markel brothers read this book when it was published in the mid ‘90s and said it was important to their thought process behind their strategy of operating and growing the company. This was what they wanted for Markel, a company that could stand the test of time and be a great place to work.

In summary, Markel is in a fantastic position. They have an outstanding reputation and are poised for many more decades of growth and value creation. I hope you found these notes and my thoughts about Markel to be useful.

Why Motorola Solutions Ought to Be Attractive to Private Equity

After listening to Motorola Solutions’ 2015 Financial Analyst presentation this morning and thinking about the actions the company has completed in the past year, I am even more convinced the company is ripe for a takeover by private equity or by a larger company in the defense industry. Even if a takeover does not materialize, Motorola is in an excellent position to continue delivering good returns to public shareholders. Here’s an outline of my thoughts.

Actions Taken Over the Last Year

  • Pure Play Company
    • Sold Enterprise division to Zebra Technologies for $3.45 billion and is now a pure-play company focused on providing mission critical communications devices and services to public safety and commercial markets.
  • Expense Reduction
    • Operating expenses as a % of sales reduced from 38% in 2012 to an estimated 26% for 2015.
  • Pension Obligation Reduction
    • Took $1.9 billion pension charge this year to reduce liabilities. The need for cash contributions over the next 5–6 years will be minimal or non-existent.
  • Shift in Sales Focus
    • Company has shifted its focus from selling products to selling solutions, services, and software. This process is ongoing, but the result will be a company with more predictable and recurring—i.e., more valuable—revenue streams.

Why Would Private Equity Be Interested?

Private equity ought to be interested in Motorola given its excellent balance sheet, market leading position, limited competition, sticky customer relationships, and high barriers to entry.

  • Financial Reasons
    • A pure-play company is more attractive than a company whose attention and resources are divided.
    • The pension obligation reduction has eliminated a potential sticking point in takeover negotiations. A buyer no longer has to worry about contributing to the pension in the short- and medium-term.
    • Motorola still has a net debt position of approximately zero.
    • The amount of predictable revenue streams is growing, which means the owner of the business can use a greater amount of debt and leverage.
  • Competitive Advantage Reasons
    • Customers need 100% reliability in their products and services. Motorola can charge a large premium for this. This also means switching costs can be high.
    • Customer relationships are decades old in some cases, highlighting sticky customer relationships and more evidence of high switching costs.
    • Sales growth is in line with GDP growth. It’s not so high that it will attract new competitors and not so low that Motorola is a bad business to own.
    • Lead times to completing a sale or winning a contract are very long, sometimes years. This favors the large, incumbent company with the resources to endure the expensive sales process.

What If There Is No Takeover?

Generating a good return by owning Motorola shares is not dependent upon a takeover bid from private equity. Everything Motorola has done makes the company attractive on a stand-alone basis as well. It actually could be more attractive for the company to remain public and thus allow its current shareholder to compound their returns tax-free for a longer period of time.

In the short-term:

  • There is still some room for margin improvement;
  • The company will be repurchasing ~$600 million of shares each quarter this year, which would take out roughly 16.5% of shares at current prices; and
  • The dividend yield of 1.95% ($1.36 per share) is not too shabby.

Biggest Risk

The biggest risk I see is another year or two of stagnant sales, but I see this as a short-term risk. Over the long-term, I see Motorola as a highly-dependable business whose products and services for public safety employees around the world will always be in demand.

Danaher to Acquire Nobel Biocare for $2.2 Billion

Danaher (DHR) early this morning announced plans to acquire Swiss-based Nobel Biocare for $2.2 billion (CHF 2bn / EUR 1.7bn). Nobel is a leader in the dental implant industry and will become a “cornerstone” of Danaher’s dental platform.

With Danaher’s dental segment already bringing in $2.2bn of sales, Nobel will increase sales by about 34%, adding another $750 million. Nobel will also be adding about $118 million in EBITDA (EUR $91 million).

Looking at Nobel’s trailing twelve month figures, the deal multiple seems very high at 22.6x EBIT and 16.8x EBITDA. However, I believe Danaher is paying an elevated multiple for several reasons. First, Nobel is a high quality business that provides premium level products. Second, the dental implant industry appears to be at the nadir of its business cycle. Thirdly, by applying the Danaher Business System (DBS), Danaher should be able to get EBITDA margins back to above 20% in the next few years. All of this suggests an adjusted acquisition EBITDA multiple of 15x or less.

Below is a chart I created showing the financials for Nobel, Straumann (another competitor in the dental implant space), Danaher as a whole, and Danaher’s dental segment by itself. Hopefully it provides some perspective on this industry and acquisition in particular.


Although I wouldn’t call this deal a home run, I think Nobel will be a good deal for Danaher as it improves the entirety of their dental segment’s offering and there is room for margin improvements via DBS. Even after the deal, Danaher will still have $8 billion of M&A capacity after this sizable deal. Hopefully they will be able to put more cash to work in the near future.


Markel (MKL) Still Undervalued & Still Deserves To Be in Your Portfolio

I’ve personally owned shares of Markel for nearly five years and have been to several of its annual shareholder meetings. It’s high time I updated my thoughts and feelings with a fresh report on MarkelIf you’re an investor, I doubt you will find any new or unique insight into the company, but you might appreciate how I look at Markel’s historical figures.

To give you a quick summary, Markel is an asset that is (1) currently undervalued and (2) likely to grow its intrinsic value at high single-digit or low double-digit rates for a long time. And perhaps most importantly, there is just very little that can go wrong with this investment.

Rolling With Rolls-Royce

After Rolls-Royce (RYCEY) shares fell earlier this year, I mentioned on Twitter how I thought it was a good buy. It is one of the top players in the oligopolistic aero engine market (which has huge barriers to entry), has a huge backlog, growing service revenues, and a strong possibility for margin expansion as it starts to deliver engines for the newest generation of widebody aircraft from Boeing and Airbus.

The extremely thoughtful and diligent team at Ruane, Cunniff & Goldfarb have owned Rolls for a while and I have little doubt they will continue to hold it. (Reading their investor day transcripts for thoughts on their holdings is always a good way to search for new ideas and perhaps gaining additional insight into shared holdings).

Another group that has recently invested in Rolls is Volsung Management, and they have put out an extremely thorough report on the company. Volsung goes over the history of the industry in general and Rolls specifically and just does a great job of educating you on the challenges, risks and opportunities facing the company and its investors. I highly recommend reading it.

Focused on ROIC and Shareholder Returns: W.R. Grace (GRA)

With Grace (GRA) down about 4% today (apparently analyst expectations were too high), I thought it would be a good time to do a short post on why I think Grace will provide shareholder returns in the 10-13% range for the long-term. The short answer is the company’s absolute focus on returns on invested capital. I will borrow a lot from Grace’s investor day presentation this past March.

But before we get to the specific financials and past performance, let’s take a quick look at what Grace does.


Grace is a specialty chemicals company with three segments spread fairly evenly across the world: catalysts, construction products, and materials technologies. A very high 70% of sales come from products with #1 or #2 in market positions.

Now for some amazing historical figures!


The company grew sales from $1.8bn to nearly $3.1bn. Gross margins improved from 30% to 37%. ROIC went  from 14.6% to 37.4% if you exclude their recent UNIPOL acquisition. The share price went from about $1.50 to yesterday’s $101 per share. All this is even more impressive given the fact they were under the protection of bankruptcy during this entire period as they dealt with some enormous asbestos liabilities.

So how were they able to achieve such results? It’s all about ROIC. They got out of businesses that were becoming commoditized and devoted capital to higher margin, higher return businesses and products. Grace instituted lean and Six Sigma business practices. They eliminated a lot of bureaucracy and created what I think is a somewhat decentralized organization structure of three business segments, each one supported by the corporate office.

The nice thing about the focus on higher margin businesses is it usually means Grace has to partner with or work closely with their customers on creating highly specific solutions to their needs, which turns into long-term relationships and greater stability in sales growth and higher switching costs for the customer. It’s a nice virtuous circle.

So Grace has done exceptionally well in the past five and ten years, but what is likely to happen in the future?


Over the next five years, Grace expects sales growth at 1.5x global GDP, slightly higher gross margins, >$400 million in free cash flow per year, pret-tax ROIC of >30%, and continual share repurchases. I think it’s also important to note Grace does not factor in any potential future acquisitions.

In terms of capital allocation, Grace currently feels their greatest opportunity is reinvesting in the company, but they will still have excess capital which they will be returning to shareholders assuming they have no other capital investment or acquisition opportunity that meets their return threshold.



As you can see in the above slides, Grace expects to return >$2 billion to shareholders over the next five years. I think they are giving a conservative estimate here and the more likely figure could be $2.5 billion, or about 1/3 of their current market cap.

In summary, and despite today’s slide in share price, Grace has a lot of the qualities that will produce above average returns for shareholders:

  • Experienced management team focused on capital allocation and ROIC;
  • Lean culture and processes;
  • High margin products with sticky customer relationships;
  • Dominant positions in the vast majority of their products (70% of sales come from products with #1 or #2 market positions);
  • Strong balance sheet with net debt to ebitda of 2.6x and fully-funded pension plans;
  • Opportunities for further margin improvement; and
  • Returning excess capital to shareholders via regular share repurchases.

If I haven’t convinced you yet that Grace is worth looking at in more detail, consider that Grace was Ted Weschler’s largest position when he was running Peninsula Capital before being hired by Buffett. As Weschler wrapped up his partnership, Grace shares were distributed in-kind to the limited partners and to himself. He received 3.74 million shares of Grace, which right now is about 4.8% of current fully diluted shares. I doubt he’s sold any of this position.