A global investor

John Sampson is the Chief Investment Officer of JBS Investments – a very small fund based in Sydney. They’re a global investor and have fascinating systems that they use for investing.

John is a follower of Warren Buffett and their fund has been going for 10 years, with a compound return per annum since that time of 23% after fees.

But the fees are steep, 2% plus a 15% performance fee and the hurdle rate is 5%. But if they’re doing 23% compound after fees then that’s pretty good.

It’s a really interesting chat, so even if you don’t want to invest in the fund, it’s interesting to hear how they go about doing so.

Here’s John Sampson of JBS Investments.

Well, John, perhaps we could just get through some nuts and bolts of your fund to begin with.  How old is it, when did you start it and how much money is in it now?

We started the business nearly 10 years ago.  In June it will be 10 years.  We have a wholesale fund and we recently launched a retail fund and we manage a touch under $100 million dollars, so we’re a minnow in the funds space. 

You started in the middle of 2008 which was an interesting time to start.

It was a very interesting time to start for a few reasons.  On the one hand, if you have cash there were amazing bargains.  But I think we started in June ’08.  The craziness sort of hit at the end of ’08.  We were fortunate that we were struggling to find ideas because we’re cheapskates and we like to pay a very low priced cash flow typically.  We were sort of struggling to find ideas.  Things were expensive and so we were lucky to have a lot of cash at the time things began to get cheap. 

But it was a hard time.  Your emotional muscles were tested a lot during that time.  You buy things cheap and find a few months later it was even cheaper and that’s sort of when you’re tested.  Do you buy more?  Do you not?  Do you sell?  And that’s where it comes down to your level of conviction about the idea, how much do you really believe in it?  And usually that comes back to how good your research is and how well you understand the company and where it is in the business cycle. 

Just a bit more about the fund, what’s been your return since inception?

Over the 10 years, our long term track record is a touch under 23% compounded per annum, net of all fees.

Net of fees?  Right.

Yes.

And what are the fees?

Our fees are 2% and we have a performance fee of 15% above a hurdle.

And what’s the hurdle?

It’s a 5% flat hurdle.

At 23% per annum you’ve been getting quite a juicy performance fee.

We have, it’s lovely.  Some years are better than other years.  Some years you don’t get a performance fee, however, we like the incentive of it.  Myself and the key members of the firm, we’re large investors in the firm, so our money is where our mouth is.  For me, if I’m an investor looking at a fund, I like a fund where the managers have skin in the game, first of all, and secondly, they are incentivised to perform.  Otherwise it becomes an asset gathering game to some degree.

And do you intend to cap your fund or is it open-ended?

Periodically, we’ve soft closed to new money.  We like to grow organically from our investments rather than just sort of gather as much money as possible to manage.  We have a plan to sort of hard cap at sort of $200m now, we think that would be a good point we get to in our strategy.

Does that apply to the total?  You’ve got two funds now, one wholesale and one retail, will they each be capped at $200m or $100m each?

Yes, each at $200m, that’s right.

When did you start the retail fund?

We started a year ago.  It’s called Strategic Global Fund, it’s got a different name from the rest of the business, JBS Investments.  We wanted to be a standalone retail brand and sgf.com is their website. 

Are the assets in that fund identical to the others?  Are you separating the management of the assets?

The only difference is our retail fund.  We don’t do any short-selling, we don’t own derivatives, we don’t hedge currency.  We’ve got a little bit more flexibility in the wholesale fund.  The wholesale fund can short.  Historically, we like to be long only investors.  We like to understand businesses and own them, but periodically we’ll have a short position.  We only have short position at the moment.

What’s that, if you don’t mind me asking?

Happy to discuss it.  It’s a bank in Puerta Rico which is a sad situation.  We’ve actually supported a charity there – it’s an awful situation with the hurricane that’s hit there.  However we’re opportunistic investors, so we look for opportunities around crises.  Usually it’s in a positive way when we look, but sometimes we see a company like this bank where they haven’t marked down their assets to reflect the new economic reality.  In Puerta Rico most businesses are still sort of lacking reliable power, people are migrating away from the island and believe it or not, this stock has actually gone up, this bank, since the crisis which is difficult to believe, but at some point over the next year we see all the economic reality will hit home.

There’s a large number of homes that have been wiped out on the island and most of them don’t have insurance.  It’s very hard to, as a bank to collect on a default if the house is not there.

It sounds like a pretty obvious short, doesn’t it?

It is.  And the nice thing with a bank too is, shorting can be scary and the key is to manage the risk of it going wrong.  The nice thing with a bank like that, there’s a limit to how high the price on something like that can go as opposed to – I’m always terrified of a valuation short.  If something’s three times as over-valued as it should be, why can’t it go to six times?  It’s not necessarily crazier.

With the retail fund, what’s the minimum investment?

Minimum investment is $20,000 dollars.  We always wanted to have a retail fund and the wholesale fund has a $200,000 dollar minimum.  We always wanted to do that, but there’s more compliance costs setting up a retail fund, so we’re thrilled to have one now.

You say that in your investment process it’s quite different to other value – you’re a value investor but you reckon you’ve got a different way of approaching it to most other value investors who work backwards from finding something cheap.  Explain how you operate.

Yeah, so we flip around what the average value investor does.  The typical value investor will screen on the numbers, they’ll do a statistical screen on the numbers and find things that have say, low price to book, low price to earnings.  Then they’ll have to work backwards to say, well why is this cheap?  That will sort of tell you that the security is cheap but it won’t tell you why.  We flip that around.  We don’t do number searches.  We actually start our idea hunt, we read a lot but we also do a lot of word searches.  We look for areas of the market where we think we will find companies that are misunderstood.  That could be for us typically an event, so we’re looking for events.

The event could be an oil spill in the Gulf of Mexico, it could be a disaster in Puerto Rico.  But it could also be something corporate related – a large company decides that it doesn’t want to own a small division and so it spins it off, so we track spin-offs from companies.  We track companies coming out of bankruptcy.  Anywhere where we think that there’s sort of a heightened level of uncertainty, it could be a country no one wants to touch or a currency collapse, the idea is to come after the event.

We find in those situations you typically find that the normal investor – it’s a bit too hard for them, it’s a bit too tricky.  So, we then conduct our in-depth research, we pull apart the company and work out, well we expect it will be misunderstood.  Then we’ll value it and then we’ll look at the price it trades at.  We’ve always found if you don’t value it before you look at the price, the price it’s trading at and the market will influence you whether you like it or not, you’ll sort of anchor to that price. 

How did you take advantage of the Deepwater Horizon oil spill?   Because you did, didn’t you?

Yes.  Awesome environmental disaster, obviously, but we’re opportunistic about such things.  We naturally thought, okay, there’s been this huge oil spill in the Gulf of Mexico, they have banned drilling, we expect to find some companies where the baby’s thrown out with the bathwater.  The most obvious one to have looked at would have been BP.  We thought that was too hard, we found the contingent liabilities of how much is it going to pay in law suits?  It’s hard to be tracking.  We culled the number of companies we started looking at.  We looked 50 companies, we honed it down to our favourite companies that we had found where they wouldn’t be overly impacted by the disaster.

What we found was an amazing company called TGS-NOPEC out of Norway, very well run, run by American management who tend to drive their companies a little bit better than most countries in terms of shareholder value.  The stock had dropped because a lot of its earnings came from the Gulf of Mexico.  This company, a very unusual business.  It basically maps the seabed for seismic data, it then licences that data to oil and gas companies which they use to work out where to drill.  It’s a very capital light business, they lease the ships and as they build up this library, it’s sort of like a monopoly of data. 

Very clever business model, the clients pay for the survey and then after a period of time TGS has ownership of the data and if technologies improve they license it out to other groups.  When we looked at what impact the Gulf of Mexico oil spill would have we concluded that it was really going to be bad news for a few quarters, but a year out it’s not going to matter.  They can move their ships elsewhere, there was still a huge demand for their services, they could move it to Brazil.  The end result from an investment point of view was the stock doubled after we bought it.  

Nice!  You don’t just buy the events like that, do you?  There was a company in Israel that you lit on, tell us about that. 

Yeah, so that was a company called Taro Pharmaceuticals, it was a generic drug business.  With generic drug businesses, the better ones profitability wise, make creams and other products that are a little bit harder to get approved.   They cost more to get approved by regulators, so margins tend to be a little bit better than someone replicating pill form drugs.  Within a generic company it’s a little bit of an under-followed market.  We’ve had good results looking at Israel because there’s less eyes on it than say, Australia or the US. 

We’re also really familiar with a company called Sun Pharmaceutical which is a huge generic drug business out of India.  They had a long history of taking minority stakes in companies in their space and putting their superior processes in play, tapping into their sales organisation and lifting margins thematically.  We’ve seen them do that with a couple of other companies before.  Taro had been around a while, it was very cheap.  It did get close to bankruptcy and then Sun Pharmaceutical came in, so that was the event that caught our interest.

At the time they purchased the business, Sun’s margins were about 4 times higher than Taro’s.  They also announced a plan to up-list.  Taro was trading on the over the counter (OTC) or the pink sheets in America, sort of like their second division, if you like, in stock market terms.  They announced a plan for the up-list to the New York Stock Exchange, which is something we always track, up-listings, because many funds and institutional investors are limited to – they can only buy on a certain exchange.  Many of them are limited even more and they can only buy the top 200 stocks etcetera.   It’s something we’ve tracked before, when a company has gone from the minor leagues to the major leagues, if you like. 

That’s what happened with Taro.  We paid I think it was about $12 a share and we sold early as it turned out.  We sold for about $60 and felt very clever and we thought that was a fair price and we had other ideas to move on.  It probably trades at $100 today and they’ve gone up to probably $200, so we left a bit of money on the table but we don’t mind that.  If we think it’s fair value we’ll move onto the next idea.  Sometimes that happens.  

How do you determine whether a company is cheap?  What are the measures you use?

Our favourite measure – and again, I guess the first point when looking at any company is you want to cull it down to businesses you understand with relatively predictable earnings.  Our favourite metric is enterprise value to free cash flow and we like to buy things typically under seven times that multiple.  Enterprise value, your net debt plus your market cap, and we like to use free cash flow, and we’ll make a lot of adjustments to the numbers ourselves based on the situation.  We’ll pull out any non-recurring earnings.  If they’ve just sold a piece of land they happened to own, they’re not going to do it again in the next two years, we’ll pull that out of the numbers.  We’ll make a lot of adjustments to that.  Again, every company is different and company valuations change as things happen.  We’re constantly revaluing, conducting fresh valuations of the companies we own to work out, is it fairly priced?  Is it cheap?  Do we buy more?  Do we sell?  Do we hold? 

And why seven times, where do you get that from?

It’s not a hard rule.  It’s just sort of if you look as a sort of historic investment, the better businesses, the cheaper you buy them, the more money you make on them.  So, it’s not a hard rule.  It depends on the investment thesis.  Every position we own will have a separate investment thesis for it and sometimes we’ll own the company because it trades at a large discount to say, a subsidiary that’s trading on another market or a discount to its book value, it depends on the industry of the company.  We also like to use comparable valuations a lot.  We like to look at the comps. 

We like the company to be cheap on an absolute basis, but we also like it to be cheap relative to its sector, but we like both.  We wouldn’t buy something that’s cheap relative to its peers if we felt the whole peer group was over-valued.

Why do you use free cash flow rather than profit?

It’s harder to manipulate cash.  It’s just a safer measure.  I tend to find investors, when doing valuations, the places they will go wrong is they will ignore debt which is unwise, that’s usually where you see the worst mistakes, or they don’t focus on free cash flow enough.  There are many situations.  I think the reality is management teams have a lot of scope to manipulate earnings if they want to, using reported net income numbers.  You see it a lot, especially I think most of the abuse takes place in sort of the adjusted numbers that management teams like to guide you.  They’re usually not worth the reported numbers you’ll find.

And I guess the benefit of free cash flow versus simply cash flow or EBITDA is that it takes account of capital expenditure that’s needed in the business to keep it going. 

That’s right.  And again, we spend a lot of work adjusting our numbers thinking – I’ll pick an industry – Railroads, their capex is always a lot higher than their depreciation charges.  So we like to sort of get a feel for what’s the real capex on a business.  We also find that you have to pay your interest.  Using EBITDA is a great way to go wrong, we find.

The free cash flow is also after interest, not before?

Yes.

The enterprise value, I suppose the advantage of that is it takes account of debt as opposed to simply market capitalisation and the price.

That’s right.  It’s one thing to think about the equity you put into a house and another to think about the equity you put into the house plus the debt on it.  I think that’s where I see the most mistakes that investors make in some of the valuation spaces, they ignore debt.  We’re in a really weird environment for debt, right?  Interest rates are at 5,000 year lows, which is interesting, even in BC times, money lenders like to be paid interest and now interest is so low and that’s something we’re thinking about too. 

We probably own a few companies that have probably a little bit more debt than we normally would like because we feel it’s very easy for most companies to rollover their debt at the moment.  It’s always something to watch, debt.  Companies without debt don’t go broke very often. 

You seem to, in many ways, be similar to Warren Buffett’s approach to investing, particularly with your approach to cheapness and value and so on.  Firstly, is that deliberate?  Have you kind of followed and modelled yourself on Warren Buffett or is it just the way it’s turned out?

Everyone loves Warren, right?  That’s a flattering comparison.  There’s a few amazing things.  The way I came to investing was that I was a lawyer and I actually picked up a book on Buffett and I got the investing bug and it sort of became my hobby and my profession, what I love to do.  There’s a few amazing things with Warren.  One of the amazing things I think is his level of discipline.  If you look at all of his stocks from like the first things he ever bought, he’s made money on 99%.  Yes, sure, he’s a genius, but I think that also speaks to how disciplined he is.  He plays in his fan pack, he only owns things that he understands.

And look, that number’s probably a little bit flattered by the fact that he doesn’t sell things a lot.  Over time, he might be up 2% on some things, but it’s an amazing track record.  We aspire to that and we don’t come close.  We’re probably slightly below 80% in things we buy we’ll make money on, it’s probably roughly that.  We’ll be hopelessly wrong, 20% of the time.  But the twist, I guess, on what he does and what we do is we’re a bit more event driven.  We found that that suits our style and the great thing with investing is there’s so many different styles that work, but for us we like the event driven value stake. 

When I started investing I used to reverse engineer Warren’s historic investments as sort of a learning tool and say, what multiple did he pay for this?  Going back and reading the old Coca-Cola reports, the broker reports on American Express when he was buying those things and getting a feel.  What price did he pay?  What did he read to see?  Because these things sort of repeat in different ways.  What’s really interesting is the events driven investing we do, he actually did a lot of that.  He often would own spin-offs, he would often own things that had just sold a division that lost money.

It was quite interesting to see that he did do that and I wonder if he was a smaller investor he might still do a lot more of that kind of investing, but he’s got bigger problems, good problems - $100 billion dollars of cash!

Yes, that’s right.  Well, I think his biggest winner at the moment or one of his biggest winners has been Bank of America and that was definitely an event driven investment back in the middle of the GFC.

Yeah, we never owned Bank of America.  We bought the TARP – the US government had a program called TARP, the Troubled Asset Release Program, whereby the US government bailed out certain financial institutions, AIG, etcetera… And as part of that the government got warrants which gave the government the right but not the obligation to buy shares in those businesses at very cheap prices relative to where these things are now.  What the government did that was really interesting is they sold those, they listed on the share market.  

We owned the General Motors TARP warrants and we owned the JP Morgan TARP warrant.  We love a weird security and a TARP warrant, it’s not like a normal security, so you’ve got to do a bit of reading to understand it.  But if a stock’s up, the warrants might have gone up five-fold, to give you an idea, without more risk or anything like that because they were very long-dated warrants.  For General Motors, one of the warrants, you could General Motors shares at $10 dollars and you had the right to do that until say, six or seven years – something like that, I forget the timing, they expired in 2020-something.  The stock started listed at $30, so you’re on the money straight away on them.  They were great.  So we never owned Bank of America but we owned similar things around that time. 

One of your key principles is concentration rather than diversification, which is also a Warren Buffett principle.  How concentrated are you?

It depends on what our available investment ideas are.  I’ll say upfront, it’s very hard working out the appropriate concentration level for an idea.  The way we work it is we sort of have an internal rough scale of one is a terrible idea, then there’s the sell your house, put everything into an idea which you don’t get a lot of, we’ve probably had two of them ever.  If it’s a 10 idea we’ll make it a 30% position.  If it’s say, an 8 out of 10 idea, it’ll be like a 10-12% position.  Compared to the average fund, we’re very concentrated.  Compared to private investors, we’re probably not as concentrated as some private investors. 

But our typical position for us might be 10%.  We don’t like to put on a position if it’s less than 5%.  We think if it’s not worth being a 5% position, we probably don’t want to own it.  Sometimes we hold a lot of cash, you know, and we’ll wait. 

Okay.  First, how much cash do you have at the moment?

At the moment we’ve got probably historic highs.  One fund is about – we’re about 50% cash in our wholesale fund.  That’s really just because we’ve just sold our two biggest positions.  They both tripled over about three years.  The thesis had played out, time to move onto the next one, so we sold them just before the [unclear 24:29], but that’s luck rather than foreseeing such jitters and we’ll just be patient as we redeploy that.  Our cash levels can vary between, we like to keep sort of 5 to 10% cash at all times and sometimes it runs at about 15%.  We like our drive now.  If the market gives you a good idea usually you only have a small window…

Did you say you’re 15% cash or 50% cash?

50%.  At the moment we’re 50%, which is unusual for us, but again we sold our two biggest positions.

Well that’s the cash position of a pessimist.

It is, but what I’m saying is we’re not pessimistic.  We’re always finding great businesses.  Somewhere in the world there’s a business on sale that you want to own.  It’s more a function of the fact that our two biggest holdings had tripled.  We viewed them as fairly valued.  One was called BDX, one was called Kenon – you can look at the graphs.  We felt they’d had a pretty good run, so we closed those positions.  We owned both of them for around about three years, one was three and a half years.  And we’ve got some ideas, so we’ll redeploy that capital going forward.

What are your positions at the moment?  What do you own at the moment and tell us about them?

I’ve got a few interesting ideas at the moment.  As you’ve gathered, we’re global investors.  We’d love to own more things in Australia but we don’t have any Australian ideas at present.  We find it’s quite an expensive, well-covered market.  We like to sort of look for niches further afield.  One interesting idea we own is Genworth in the US.  This is a parent company, there is a locally listed mortgage insurance business here.  Genworth is in a very interesting situation.  It used to be a huge company, it’s a shell of its former self and it’s subject to a takeover offer from a Chinese group.  The shares currently trade just under $3, about $2.85.  There’s a takeover offer on the table for $5.40, so nearing sort of 80%.  There’s two ways to win with this situation.  Obviously, with the Trump administration voicing a very anti-China position, the price reflects the fact that the market does not think this takeover will close and the takeover’s been hanging around for about a year.  When the takeover bid was initially made it was only a 5-10% premium to where the stock was trading.  It’s sort of been nearly cut in half.  At the same time, the comparable businesses in the States have risen about 40% over that time period.

People are saying the Trump administration will block this deal because it’s a Chinese bidder and we’ve seen the Trump administration block a lot of Chinese deals.  We reviewed all of these transactions one by one and the common theme to those transactions that were blocked was there was some form of national security issue or potentially a privacy issue.  Privacy in terms of American consumer’s data going to the Chinese entities and arguably the government. 

What’s interesting with Genworth is they’ve amended their proposal to the regulators saying, we’re going to have a third party to look after all of our privacy data.  On the one hand, we think there’s a good chance, probably like 60/40, that the transaction will close, we have an 80% gain.  What’s really interesting though, what happens if the takeover fails?  Our general view on situations like betting on takeovers is it’s a very bad idea, you need very specialised knowledge, you basically need to be an M&A lawyer or have them on staff.

What’s really interesting here is that after the takeover bid got announced, long term holders of the stock sold.  The companies who have been listed and it’s a deep value investment, why own it?  So as a result, the current price is trading at about 2.8 times earnings.  A PE of 2.8 for pretty good businesses.  The market cap’s about $1.5 billion dollars, so on a sum of the parts basis we get a valuation of about $8, so we feel there’s huge upside.  Our ideal situation would be the takeover bid actually falls away and we think the shares are worth around about $8 to $11 and they’re currently trading under $3, but should the takeover go through we make 80%.  It’s sort of, heads, we win, tails, we also win.  We think that’s an amazing situation so that’s one of our larger holdings. 

What else?

One of the more interesting things we own is in Russia.  It was obviously a currency crisis, I’d say probably the most hated market in the world.  Even last year you could buy the third biggest port company in Europe, a company called NCSP, it trades on the London Stock Exchange.  You could have bought that for around about 2.5 times earnings and a dividend yield paid in US Dollars twice a year of 40% per annum, which is incredible.  So that took our interest and then we kept digging into it and – there must be a catch?  Maybe they’ve got to give back the lease on the port or – and the more we dug, the better it got, the story.  They own the underlying land.  There was no special taxes which ports often have to pay.  It’s also an export port. 

The currency collapse helped them.  They get paid by their customers in US Dollars, their costs are in Rubles.  As the Ruble is weak, the entities in Russia that produce oil will pump through more oil, so that was sort of an amazing opportunity.  That’s sort of one of our favourites.  The shares have gone up a lot since we bought them, but even the dividend yield today is like 15% which we think is amazing for a literal monopoly business.  

Interesting.  Well, look, I could go through all this all day, John, but we have to finish up there.  It’s been very interesting talking to you, thanks very much, I appreciate it.

Thanks for the chat, Alan.  Cheers.

That was John Sampson of JBS Investments.