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RUSSO & WEITZ – DYNAMIC VALUE DUO – Transcript 1/03/2014 #1028

January 27, 2014

CONSUELO MACK:  This week on WealthTrack, a dynamic duo of super value investors! Wally Weitz of the Weitz Funds and Tom Russo of Gardner Russo & Gardner search high and low for extraordinary bargains but find them very different places. Two great value investors are next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. This week for our first show of the New Year, we have a WealthTrack exclusive with two outstanding value investors together on television for the first time, although they are good friends and have known each other for many years.

Wallace Weitz is the founder, president and portfolio manager of the Weitz Funds where he started the flagship Weitz Partners Value Fund as a private partnership thirty years ago. Since its 1983 launch, this Morningstar favorite has racked up market and category beating returns. Weitz now co-manages Partners Value, Weitz Value Fund and Hickory Fund but is the sole manager of the Partners III Opportunity Fund. Although his funds tend to have low turnover rates, Weitz is an active manager. He will go through periods where the values in the market are so compelling to him that he becomes fully invested. Other times when he sees limited opportunities, he will trim positions and raise large amounts of cash. Right now he is carrying about 30% in cash in Partners Value.

Tom Russo is a partner in the investment advisory firm Gardner, Russo & Gardner where he has run the Semper Vic Partners Fund for nearly a quarter of a century. Since Semper Vic’s 1990 launch it has also delivered market beating returns. Russo, who also has very low turnover in his funds, tends to stay fully invested and specializes in holding global brand name companies mostly based overseas and many family-controlled.

Although their view of the values in the market are very different as are most of their holdings, they have one big thing in common. Berkshire Hathaway is one of the largest holdings in each of their portfolios and they are huge fans of Warren Buffet. Before we discussed those similarities, I asked them about where they diverge- how difficult it is to find value in the current market.

WALLY WEITZ:  Very difficult. We look at companies one at a time and measure the business value and want to buy at a deep discount to that, and that doesn’t exist in this world. We found two or three new companies in the fourth quarter, so obviously it’s not zero, but we’re not enthusiastic about the price we’re paying, so we’re taking little positions and hoping the market will go down.

CONSUELO MACK: And 30% in cash?

WALLY WEITZ:  Thirty percent plus or minus in the stock funds in cash, yeah.

CONSUELO MACK: So Tom, but you on the other hand, a value investor, are pretty fully invested.

TOM RUSSO: Yeah.

CONSUELO MACK: But that’s all the time. Right?

TOM RUSSO: It is. I tend to be fully invested. Insofar as my allocation for most of my investors, it’s just for a small portion of their funds with the idea towards accessing the kinds of businesses that I focus on which have a very long horizon. They’re global businesses that are investing against the future for quite a long time. In assets, for example, one of the things you have to wrestle with is that with upfront investing that’s quite considerable, the P/E ratios for those businesses are often overstated because the earnings component of that ratio is burdened by the investment spending that takes place when you’re building out the network for a Nestlé or a Heineken around the world.

WALLY WEITZ:  But I think Tom and I both think about business value versus price, not statistically cheap P/E or price to book and that sort of thing. We’re thinking about discount to the value to a business person, and a company that actually grows, that actually has stability and a great 10 or 15-year runway is worth a lot more than some very ordinary cyclical company that may have a low price/earnings ratio. So we would agree on that, and if you looked at our portfolio today compared to 10 years ago, you would find our average P/E much higher and the quality of our companies much higher.

CONSUELO MACK: But the difference is that you do an analysis of the business value versus the price. Right?

WALLY WEITZ:  Right, right, right. We measure not only the price to value of every individual stock, but we look at the weighted average price to value of the whole portfolio, and so in March of ’09, our weighted average price to value is like in the 40%  range. Today it’s like close to 90%, and that doesn’t mean it’s going to go down.

CONSUELO MACK:  We hope.

WALLY WEITZ:  Well, it probably will go down temporarily, but the point is the odds of doing very well from a 90% is a lot lower than the likelihood of doing well from 40% if we’ve measured it right, and so we’re just trying to play the odds and put the odds in the investor’s favor, and even though we’re 30% in cash, we are 70% invested, and we’re invested in Berkshires and Transdigms and Liberty Globals and companies that there’s some overlap with Tom, but the conceptual overlap is very considerable.

CONSUELO MACK:  So what changes are you making in your portfolio based on what’s been happening in the market?

TOM RUSSO: There are rebalancing portfolio changes that take place regularly and that often occurs in part because some position has moved up to a higher percentage weight than it probably warrants in light of the events and its share price and the resulting discount to its intrinsic value. You have that movement up, and it’s often happening at the same time as other businesses for reasons that might not bear merit have gone down in value. And so their discount from their intrinsic value deepens, and so on the balance, that rebalancing adds value I think from moving from the overweight, less undervalued to the less weighted, more undervalued. You know, the one thing I would say is the amazing thing about the 40% discount scenario that Wally referred to in March of ’09, the issue was you had to get up from under the table to see those values, because in March of ’09 it was a really scary time.

CONSUELO MACK: Right, the world seemed to be falling apart.

TOM RUSSO: It was extremely important at that time that you just kept your investors invested, because their instincts were to just pull out of the market, and with a full investment sort of bias, I go through the same type of swings that Wally does, but at some point I think a value to the investor is just to know that the businesses have an embedded direction, and the market can swing as it does, and we can add some value through the rebalancing, but at the end of the day, it’s better to own great businesses than not.

WALLY WEITZ:  It was good to have cash in March of ’09, and we couldn’t wait to get it invested, and it really helped the rebound off the bottom, and I think it’s times like that that sort of reinforce the idea for me of being comfortable with high cash positions when things are expensive, because it seems that the opportunity cost of the cash… I mean, I don’t worry about it earning zero. Sometimes zero is the best there’s going to be.

CONSUELO MACK: Better than losing it, too.

WALLY WEITZ: But having cash in times of distress is important, and that’s really what investors pay us for, whether they realize it or not. It’s so that we will be investing or staying invested at bottoms and not letting them panic and shoot themselves in the foot.

TOM RUSSO: All out of the market is a risky position even though it may be driven by a fear of risk. Being all out of the market is itself a risky position, and that’s why we try to balance back and forth with the percentage weight. The notion of having cash and the value of having cash can also surface within the companies.

WALLY WEITZ: Absolutely.

TOM RUSSO: So Nestlé in 2011, the second half of 2011 had a terrific opportunity to make three acquisitions that built their franchise substantially stronger in China. Most of the world had fled China in the second half of 2011. Chinese stocks had collapsed, and the market wasn’t rewarding anybody for being anywhere close to China, much like today, but Nestlé went into that market and bought a beverage company, bought the largest confectionary company and bought Wyeth’s infant formula business exactly because they could at compelling prices, and then on top of that they might go in and buy back some stock during a downturn. If they have cash and they have a long-term mindedness, they will build more value for us during those sharp downturns than not.

WALLY WEITZ: And Berkshire in March…

CONSUELO MACK: So let’s talk about Berkshire because we’re talking about some differences and similarities, but the two of you, your largest holdings or one of your largest holdings is Berkshire, so talk about Berkshire, Wally.

WALLY WEITZ: Well, Berkshire is a collection of businesses that Warren’s put together over 50 plus years that generate excess cash. They send a billion or two home to Omaha every month for him to reinvest, and he does let cash pile up at times, and so when we got into the financial crisis and Goldman, they needed money badly on that Sunday afternoon, he was able to get fabulous terms and the same for GE and the same for Bank of America. There are plenty of people who have high IQs or who are driven or are great business minds or a lot of these other characteristics. Warren has them all, and what’s great about Berkshire from my point of view is it will be a totally different company if you were to just look at it every 10 years, but the organization of it and what he’s doing with the cash flow will be consistent, and so you can close your eyes, and maybe every time I’ve been on your show you said, “Well, what’s the one stock?” and I’ve said, “Well, Berkshire Hathaway,” because you can leave it alone and trust Warren to reinvent.

CONSUELO MACK: To transform it?

WALLY WEITZ: Reinvent it as needed and continuously over time and be totally disciplined. There’s criticism in some paper recently about Warren’s investment record isn’t so great because he uses leverage, because he has $75 billion in float which is like an interest-free loan for him, but there’s a lot of people who have access to leverage and have blown themselves up in a much shorter period than 50 years, and so for him to be able to keep buying the stocks that look kind of boring to people on the outside, the Cokes and the American Expresses and so on, and do it for 50 years and compound at 20 plus percent and do it in a very tax-efficient way for the investors, it’s …

CONSUELO MACK: Extraordinary. So you were just telling me that if you look at what Warren Buffett’s doing, his most recent acquisitions, the big ones, Exxon Mobil.

TOM RUSSO: Yeah, I think Warren …

CONSUELO MACK:  IBM.  Tell me about your analysis of the IBM and Exxon Mobil.

TOM RUSSO: I’ve just been struck by how obvious and how plain and how straightforward those investments are, and how enormously dull they are and how boring, and in a marketplace that’s full with stories, to see where Warren puts the capital and it’s completely ignored. Often if we have an interview in a forum like this, people say, “Why on earth would you talk in a forum like this? Because after all, won’t people copy you?” Warren’s always said that he’ll do things publicly. He’ll talk about it publicly and it’s just too dull for most people, and these are two stocks that are just too dull, but there’s absolutely no reason, if properly harnessed, that they couldn’t clearly deliver a double in which case Warren will have added another $17 billion in value to his shareholders.

WALLY WEITZ: And part of the purchase price comes from zero or negative cost, interest-free loan, indefinite-length loan from the float.

CONSUELO MACK: Right, from his cash.

WALLY WEITZ: So even if it only does 10% a year, the leverage makes it 15.

TOM RUSSO: And there’s something…

WALLY WEITZ: But they have to last, and they have to survive, and they have to not disappear overnight, and those two companies I think he believes have that. They start with that.

CONSUELO MACK: But let’s get off Warren, because I feel like so he’s a one-off, but you two invest in companies for a long term, and you told me, Tom, that for instance Heineken is… because I said, “So you’re still owning Heineken.” You said, “No, but it’s a totally different company than it was 10 years ago.” So tell me about the kinds of management that you look for that aren’t just Warren Buffett.

TOM RUSSO: I think the lesson that’s most powerful from Berkshire, to answer your question, is companies have to have the capacity to suffer when they want to expand, and so we look for businesses that have, first of all, the opportunity to expand, the capacity to reinvest that arises from the extent of history in many instances. Nestlé happens to be in 190 countries around the world, 75 active businesses around the world because they came from a small Swiss country base, and they grew organically. Heineken grew around the world because there are only 13 million Dutch drinkers of Heineken beer, and even thought Heineken beer in Holland is…

WALLY WEITZ: They over indexed, though.

TOM RUSSO: Oh, yeah… is so much more than a breakfast drink, as they call it, at some point there are only that many hours in a day, they had to look elsewhere and with them traveled their brands.

CONSUELO MACK: But that’s also a family controlled business, Heineken, whereas Nestlé is not, but that’s another thing that you two look for in kind of the initial screen is management that you can trust. So tell me about the screen of management, why management is so important, Wally.

WALLY WEITZ: Well, Tom talks about the ability to suffer. He’s talking often about families that have multi-generations. They’re completely committed to the thing and committed for the next generation.  We’re looking for the same sort of thing in a different form. We want the Buffetts, the John Malones, the…

CONSUELO MACK: Liberty Media.

WALLY WEITZ: Liberty Media.

CONSUELO MACK: I mean, you’ve invested with Malone for a long time.

WALLY WEITZ: People like the guy who runs Transdigm. It’s all about the company for him and doing a great job, and so they’re not only able to execute well. They’re smart about reallocating the capital they generate, and they can stop. You know, they just avoid listening to Wall Street. There’s a great book that was out in the last year or so called The Outsiders by Thorndike, and he profiles, what, 10 different managers, and it’s Henry Singleton and it’s Buffett,  you know, companies who …

TOM RUSSO: Tom Murphy.

WALLY WEITZ: Tom Murphy.

TOM RUSSO:  A big deal.

WALLY WEITZ: Who ignore Wall Street and do what they think is right for the company. Now, if you ignore Wall Street and do what’s wrong for the company, that doesn’t do any good, but…

CONSUELO MACK: But who can do that now besides a Warren Buffett and a John Malone? I mean, who can survive to get to that?

WALLY WEITZ: Well, a John Malone has super voting stock.

TOM RUSSO: I think that’s where you get the benefit from family controlled companies. I mean, I have probably 60% of the companies I have in the portfolio are still run by the founding families. They may have obviously professionals actually executing, but the perspective and the capacity to sustain a long-term investment is given to the management because of the strength of the controlled vote. Even yesterday there was the news that Discover Network was looking at acquiring Home & Garden TV Network. It’s called the Scripps Network, but that business didn’t exist 12 years ago. It came out of the Scripps company on the vision of a couple of managers, and they put together resources from television and broadcast and the newspaper business, and they came up with a proposal, and the family backed it and said, “We will back you,” to the tune of $150 million of operating losses over the four or five years to invest in the business.

CONSUELO MACK:  That’s unusual.

TOM RUSSO: And in today’s world particularly so, because around every corner lurks an activist, and if an activist knew that Scripps was in the midst of doing an investment for the future and came knocking on the door and said, “We demand results today,” they would most likely, if the company didn’t have control share, they would trigger the divestiture or the reduction of that effort which would be at the long-term harm of investors. So we have Wall Street that always demands something each quarter and then now this new force of activism that comes along in the midst of something that might be good long term, shakes the tree to get current numbers back a little bit higher, and then declare victory, and it may come at a horrible cost to the business, and that’s where the family control to assure them sort of a go-away pill when somebody comes along and asks for immediate results. It allows them to focus on the long term. That makes a big difference.

WALLY WEITZ: The super voting stock is more common in media land, and that really helps. That’s how Malone keeps people at bay for Liberty companies. That can work both ways. We owned TDS, Telephone Data Systems, for eight or ten years, and it was just a horrible experience because it was a family-run business.  They passed up multiple, really good opportunities, and we finally gave up and went away. So it’s not perfect, but you need the strength of character, and it doesn’t hurt to have the voting control.

CONSUELO MACK: But also activist investors can work to your favor. Right?

WALLY WEITZ: Well, they can work in our favor as…

CONSUELO MACK: As a shareholder.

WALLY WEITZ: As a shareholder, yeah, and there’s some… I mean, activist is applied to a lot of people, and there’s some loud, obnoxious activists that I really don’t welcome into our companies, but on the other hand, somebody like ValueAct, Jeff Ubben, I think has been very helpful to a lot of companies, and we’re glad when he comes into one we already own, and when he buys a new one, we take a harder look at it. He came in and got involved in Valeant Pharmaceutical and …

CONSUELO MACK: Which has been a very successful holding for you.

WALLY WEITZ: … it’s been a terrific stock for us the last year, year and a half. Now, there’s things to be scared about there, too, but he brought in a new CEO that had a totally different business model and approach and focused on the better part or the safer part of pharma land and got out of the things that were more dangerous that had patent cliffs and took a lot of R&D and that had reimbursement issues and focused on others, and he’s made a series of acquisitions and made huge cost cuts, and that can go too far. I mean, Teledigm maybe took it too far in the ‘80s, but it’s been a very successful thing, and it was ValueAct that really triggered that change and built up the comp system. You know, Charlie Munger always talks about the incentives being the most important part of any equation, and having the right comp for the senior leadership is really important.

CONSUELO MACK: So not stock options necessarily while you’re there.

WALLY WEITZ: Right. They pay their own money. They buy stock with their own money, and they stand to make an enormous score at the end but only after five or ten or fifteen years and at much higher stock prices. So the incentives need to be right.

CONSUELO MACK: So I have about five minutes left in this conversation. I can’t believe it. It’s gone way too quickly.  So let me at least get the One Investment out. So if there were one investment that you wanted to put in somebody’s long-term diversified portfolio, Tom, what would it be?

TOM RUSSO: You know, I have so many that I’d like to put in.

CONSUELO MACK: I know you do.

TOM RUSSO: In fact, they’re the same holdings that I have across the board, but I guess at this moment it might be Heineken, and it might be Heineken Holding Company, and the holding company gives us a little bit of an extra return kicker, because it’s the vehicle through which the family, the Carvalho family controls the company, but it trades at a perennial discount to the operating company shares, so we buy it at a discount, but as it sits today it trades for about six and a half times enterprise value of the EBITDA which is one measure of cash flow multiple, and it trades for about 12 times net income, a little less than that. It’s delivered to us investors because of the vision and control of Charlene and Michel Carvalho, the Heineken heirs, a vastly expanded universe in which they can invest going forward.  So they are 20% exposed to developing emerging markets 10 years ago. They’re 70% exposed to developing emerging markets today.  That includes FEMSA in Mexico, Asia Pacific, India. They have an involvement in India. All this comes from …

CONSUELO MACK: All a lot of beer companies.

TOM RUSSO: It’s all beer.

CONSUELO MACK: All beer.

TOM RUSSO: In this case, it is a beer business. It’s not like some Diageo which has beer and also spirits. Now, I have equally large holding in SABMiller, equally large holding in Anheuser-Busch InBev. It’s just that in this case for some reason right now Heineken’s valuation is much lower than the rest, and that’s why of the group I would say that would be the one. Very clear stewardship from the family, and a management that doesn’t have to look over its shoulder when they act for fear of having an activist come along.

WALLY WEITZ: Right, 3G must have their eye on them.

TOM RUSSO: I think there’s all sorts of rumors about global consolidation in the industry and the rest, but at the valuation levels plus the opportunity to redeploy capital based on the steps that they’ve taken in the past five years, I think that’s probably a good investment.

CONSUELO MACK: Now it’s Wally’s turn. One Investment.

WALLY WEITZ: I’d slide Berkshire in as a bonus pick.

TOM RUSSO: Can’t.

WALLY WEITZ: Because I’ve already…

CONSUELO MACK:  It has to be cheaper than class A, Tom…

WALLY WEITZ: I’ve done it three times before. So I try to think of another one where you have management you can trust to reinvent the company as needed, and the extreme case of that would be one of the Liberties, and I would pick Liberty Media. LMCA is the symbol. It’s now at the moment about 100 and some dollars a share worth of Sirius XM radio which they got for zero cost, and another $35 or so of Charter Communications which they are now using to try to go after Time Warner. You have John Malone. You also have another $10 or so of their public companies and another $10 of private companies, but you have a pool of really good assets in the hands of an active, smart, good manager, so it will look totally different five years from now. It’ll look totally different 10 years from now, but if somebody had to put something away, that would work.

TOM RUSSO: What is the market price?

WALLY WEITZ: Well, the market price is about a high 100, 145 to 150. Our valuation really is 160 or 65, so it’s not cheap. Nothing is cheap. Nobody should buy anything because we mentioned it today, but if you had to own some, I’m going to be happy to own that five years and ten years from now I think.

CONSUELO MACK: We’ll have to leave it there unfortunately, but that’s … so I could see Tom thinking about it right now. Wally Weitz, thanks so much for coming in and seeing us from Omaha. We really appreciate it, and from Pennsylvania, Tom Russo. Thank you so much for joining us on WealthTrack again. Great to have you two here.

TOM RUSSO: Thank you very much.

WALLY WEITZ: Thank you.

CONSUELO MACK: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: make sure you have some “boring” investments in your portfolio. Tom Russo and Wally Weitz just described Warren Buffett’s habit of buying quote-unquote “dull” companies such as IBM and Exxon Mobil that other investors aren’t interested in. Purchased at the right price, what these so called “boring” companies can offer is a history of survival, adaptability, and financial heft which gives them the ability to invest when they need to, buy back stock and pay out dividends. Over the long term those qualities can really pay off.

Next week we have our annual exclusive New Year outlook with ISI Group’s Ed Hyman, the Street’s number one ranked economist for more than 30 years running. This year Ed will be joined by Legg Mason’s legendary Great Investor Bill Miller, who is back at the top of his game.  The first of our two part series with them starts next week. In the meantime, please visit our website, wealthtrack.com for more of our interview with Wally Weitz and Tom Russo in our Extra feature. And connect with us on Facebook and Twitter. Have a great weekend and make the week ahead a profitable and a productive one.

 

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