Wednesday, February 13, 2013

Investing in “Good People”

When bad things happen to good people, the s*it hits the fan.

Posted By on Wed, Feb 13, 2013 at 8:47 AM

Let's leave schools, Rudy Gay, and Nathan Bedford Forrest aside for a minute and talk about money.

Sooner, if you're over 55, or later, if you're under 30, you're going to have to save some, live off someone else's, or scrape by on Social Security (good luck). If you are in the first category, you will probably eventually fall into the arms of a money manager by choice or because your company retirement plan makes you do so.

This is about Memphis money manager Southeastern Asset Management and its Longleaf Partners Fund, managed by Mason Hawkins and Staley Cates. Several years ago, I put my small treasure in this fund. Invest locally and you get to drive to the annual meeting, drink free wine, and hear the managers explain their hits and misses. It's easier to pay attention. And Longleaf has a good but not great track record.

The first sentence of Southeastern Asset Management's letter to shareholders in 2012: "Great corporate partners can mean the difference between a good investment return and a stellar one. Our investment criteria include having 'Good People' at the helm."

Bravo! You sure don't want Bad People at the helm. Look at Bernie Madoff or Allen Stanford. But sometimes Good People make bad decisions and lose lots of money for other Good People. Such as me. That's what happened to Longleaf investors in 2008 when the value of the fund fell 50 percent. It didn't help that Cates and Hawkins made big bets on two stocks that tanked: Dell, founded by Michael Dell, and Chesapeake Energy, run by Aubrey McClendon.

Cates and Hawkins generally keep a low profile, but for a year they have been making business headlines as activist investors. In 2012, they forced Chesapeake's board to make changes, and in January, McClendon announced he would resign as CEO. In February, Southeastern broke ranks with Dell over a buyout proposal they believe sells the company too cheap to private investors. Southeastern's trope is that "Mr. Market" undervalues stocks and creates buying opportunities for "value investors" to find great investment partners on the cheap.

"We use our vast network of clients, corporate managers, industry experts, and friends to find out everything we can about the CEO, including personal as well as professional insights," Cates and Hawkins said in their 2012 shareholder letter.

This runs contrary to the view that index funds perform as well or better and charge lower fees. As ballplayer Dizzy Dean once said, "If you can do it, it ain't bragging." The Partners Fund has an average annual return of 10.8 percent since its inception in 1987, winning some best-in-the-business recognition. But over the last five years, the annual return has averaged just .25 percent.

Dell was a hot stock when custom PCs came in shipping boxes the size of suitcases. Mr. Market has been over it for years, but not Longleaf. This was Southeastern's view last summer: "Michael Dell is one of the most vested and engaged CEOs we have as a partner."

And this was their view last week about a proposed buyout of Dell at $13.65 a share, well below Longleaf's valuation of $24 a share: "We are writing to express our extreme disappointment regarding the proposed go-private transaction, which we believe grossly undervalues the company. We intend to avail ourselves of all options at our disposal to oppose the proposed transaction."

Dell defended the proposal, saying it "offers an attractive and immediate premium for stockholders." This is hogwash that raises doubts about Mr. Dell's "Good Person" credentials. The statement is only true for investors whose cost basis is below $13. Anyone who bought the stock from 1998 to 2008, when the price ranged from $20 to $59, has earned a huge loss. That includes Southeastern, which owns 8.5 percent of the available shares.

Good People, Part Two: This was Southeastern last year on the "controversial" McClendon, part owner of the Oklahoma City Thunder: "Through our multiple industry, client, professional, and personal contacts, we gained insight about McClendon and arrived at a different conclusion than the image currently portrayed by Chesapeake short sellers and much of the media."

Mr. Market meets Mr. Media. The media bashing was a sorry excuse for analysis. The reports about McClendon's personal investment conflicts were right on target. He's out in April.

There's an old saying about investing that "the stock doesn't know you own it." But the CEO knows you own it if you're one of his top shareholders, and that presents a whole range of issues when "Good People" make bad decisions. Go get 'em, Staley and Mason.

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