12. A Global Investment Playbook
This book started with a central question: “How do you value-invest long-term in inherently unstable and uncertain environments?” Or alternately, given the rise of such environments and their increasing collision with the West, “What would Ben Graham do now?”
I have asserted that in practice this theoretical question usually boils down to five practical problems: limited access, increased current uncertainties, increased long-term uncertainties, weakened or impractical claims to the enterprise, and foreigner disadvantages. If you can overcome these problems, the circle of attractive value investments expands dramatically, and a host of companies jump from the “too hard” to the “good” bucket. And my best answer to these problems (not the only answer for sure, but my best one) is to combine traditional value-investing methodologies with value-added deal-making. To not just expand the margin of safety by demanding a lower price (the traditional answer to increased uncertainty), but to also expand it upward through added value and then to stabilize it into the future through structured deal-making.
However, I could have opted to start this book instead with a description of various projects. Currently I am working on about $175 million of investments and deals, including a Swiss water company with concessions in Madagascar, a Libyan construction project, a Saudi business school, several Chinese quasi-healthcare real estate projects, a Middle Eastern insurance company, and a South Carolina physician home-monitoring company. And I’m doing this while commuting between New York and Shanghai, where I live; Beijing and Cambridge, where I teach; and Hong Kong and Paris, where I normally stop over for a few days to rest and write. But I suspect that starting out with such an account would have seemed chaotic and somewhat bizarre to the reader.
Hopefully at this point such activity appears more logical. It’s really just one consistently applied value strategy. The investment version of Occam’s razor is that when a small group of investors is making significant money in a seemingly random way, look for the simplest strategy.
In general, I hunt for negotiated deals in underpriced and/or underperforming companies where I can surgically add value, both perceived and economic. Such deals can sometimes be enhanced with debt at entry, asset sales, or IPOs at exit, but these are bonuses and not core to a longer-term value approach.
In this chapter, I present nine value strategies as a global investment playbook. These are the strategies that I think are particularly attractive for the coming years, although many have been used by practitioners for decades. They are all variations of value investing + value point.
I present them in the order I think will seem most comfortable and familiar to Western-based readers. The first strategy is just a reiteration of traditional global value investing approaches per Graham and Buffett. The next two are value point strategies focused on the growing intersection of developed and developing markets. The next three are value point approaches for moving into a truly global posture. The final three go fairly deep into the developing-market weeds. Their order can been viewed as a “going global” step-wise progression, a pathway for transitioning from Western to global value investing. The progression can also be seen as an incremental expanding of the sphere of companies that can be captured with a long-term value approach.
Strategy #1: Buy Underpriced Good-to-Great Stocks
In addition to being the most familiar to investors in developed economies, this traditional long-term value approach is also the most efficient for global investing. Buying the public shares of a great company at a cheap price enables the investor to stay liquid and make their returns at the time of investment. It is still the most surgical and elegant of approaches.
Much of the strategy in this book addresses the fact that this approach is too limited in most rising markets, and their increasing collision with the West. Buying Chinese stocks on the Hong Kong exchange or buying European stocks with emerging market exposure is just too limited. Most of the mispriced companies in developing markets are private. And, most importantly, within this approach you have very limited tools for dealing with the five going global problems. Trying to compensate for the increased uncertainties that are fundamental to many of today’s investment terrains with an increased margin of safety leads to an impractical posture of extreme precaution. It’s not that the method isn’t great; it’s that we don’t get to use it that often. We only have one tool to deal with most problems: wait for an even lower price and thereby capture an even larger margin of safety. We get stuck between choices of shrinking our pool of potential investments, staying in Western markets, going short-term, or doing some other type of contorted posturing. I am arguing that a better solution is to build additional tools to directly address the increased uncertainties and other going global problems: searching for value + adding value + structured deal-making.
However, it’s still difficult (and a bit more work) to beat the traditional value approach of buying the public shares of a great company at a cheap price. If you can find such opportunities on the exchanges of Hong Kong, Dubai, New York, or other places, this remains the best approach. It is listed here as Strategy #1 to reiterate it as the starting point and the most efficient approach for capturing mispriced value globally. Within global investing, value point picks up where this primary strategy leaves off.
Strategy #2: Buy Great Companies on Their Knees
Earlier, I discussed some of the definitions of “great” companies. There is general agreement about what constitutes a great company’s financials for a longer-term approach: stable and protected profits with minimal capital required to run and grow the business. Different investors look for different types of companies that can generate such a financial picture. Many look for a large and stable market share or a sustainable competitive advantage that commands a share of the consumer mind. Some look for global presence and good brands. Some pursue one-of-a-kind, nonreproducible assets. And in many markets, government-limited competition remains one of the biggest factors in creating such great companies.
The objective of this second strategy, like the first strategy, is to buy already-great companies for a cheap price. However, we are expanding to private transactions, which means that we usually are looking for companies struggling with a real problem—real enough that they will agree to a private transaction at a low price. So most often we are looking for temporary business or financial problems. Such situations can include cyclical industry events, economic downturns, management problems, financial problems, and protracted underperformance. But the situation is such that we believe the company will now recover without significant intervention on our part outside of capital. We want an already-great company, just exiting a problem situation, on the cheap.
This approach works well in both developed and developing economies and is well known by value investors. I have mentioned several examples, including Prince Waleed’s purchase of stakes in Citigroup, Canary Wharf, and Euro Disney, many done as negotiated private investments in public equity (PIPEs). He is one of the most successful at this approach and has been particularly effective at going between developed and developing economies this way. Reputation, as discussed, is particularly important in this approach, and targeting underperforming companies is a way of capturing the amplified power of reputation in developing economies. Warren Buffett would be given privileged access to just about any underperforming company in India or China today. This strategy (shown in Figure 12.1) can sometimes be applied to companies that have no significant performance problem and instead are looking for growth equity or other. In all of these scenarios, access is often the primary challenge, and our response is reputable capital (and sometimes political access).
Figure 12.1. Strategy #2: Buy great companies on their knees
Recall that one of the key questions when crossing borders and going global is what is your advantage? How do you avoid being one of ten smart investors bidding for a company? How do you beat out often well funded local investors? This is a strategy in which foreigners crossing borders can have significant advantages. One advantage is greater expertise. If the company is facing issues of underperformance, you must make an important decision: Has the company been overpenalized for its problems, and has it now solved (or will it, with the injected capital)? It takes significant often technical expertise to know whether both price and performance will improve rapidly. This is an advantage that can eliminate much of the competition, particularly local.
Reputation can be a second critical advantage in such deals, because it has an outsized impact in both developing economies and in underperforming situations. When you are on your knees, whom you turn to for help has a lot to do with reputation and relationships. Third, the amount of capital required can sometimes limit competition. Both going very big and going small can eliminate many competitors.
The net result is a situation where an investor can cross borders, say from the UK into China or from the Middle East into the United States, and be in an advantaged situation relative to local investors. It is a very effective strategy for global investing, particularly in the form of PIPEs. And as previously disconnected parts of the world continue to collide, more and more variations of this strategy are becoming possible. Middle Eastern investors are buying underperforming Indonesian companies; Chinese companies rescuing discussed Africa resource companies, and so on.
A twist on this strategy is to connect large capital in one geography with struggling companies in another. Being able to come in rapidly with big capital from overseas can be a big weapon at certain points. It has more to do with size than reputation or expertise, so this is often about putting together a consortium. This technique has historically been seen as large Middle Eastern capital or emerging market sovereign wealth funds acquiring Western assets during economic downturns.
But being able to rapidly deploy large amounts of Chinese capital into Singapore or India during downturns is now becoming possible as well. If the Indian economy has a recession, investment consortiums from distant geographies can enter with this type of big capital strategy. And as developing markets are more unstable and more prone to booms and busts, this is possible on a fairly regular basis.
Strategy #3: Buy “Potentially Great” Companies, and Make Them Great
Earlier, I added a new definition of “potentially great” companies. Since we are in the business of both searching for and adding value, that means we don’t have to settle for the company as it is today. We can rapidly add value and make a company better by improving or augmenting capabilities, political access, reputation, or management. And in developing markets and cross-border situations, we have far more ability to do this surgically than in the West. The other big tool we have with this approach is orchestrating mergers. I haven’t discussed this strategy extensively, but it’s a very effective way to build great companies.
Buying a potentially great company and making it great is analogous to buying homes and fixing them up, but with three important criteria. The first is that we look only for companies that can be made into great institutions. The second is that, per Graham’s Method, we are surgical. We don’t do long-term management or other, more gradual improvements. The returns are locked in at the time of the investment. The third and most important criterion is that we depend mostly on our capability keys and management. I have characterized much of the interaction of the developed and developing worlds as consisting of capability migration and consolidation. This investment strategy rides that wave and relies on bringing in management and capabilities at various points in time.
This strategy is shown in Figure 12.2. Note that it is all about getting a low price and ending up with a great company. It also re-raises an important Graham question—whether it is better to target an attractive company at an unattractive price or an unattractive company at an attractive price. This approach basically splits the difference.
Figure 12.2. Strategy #3: Buy potentially great companies, and make them great
Strategy #1 was a quantum jump in the number of “cheap companies” we can target with a long-term value approach. Strategy #2 was about expanding from underpriced to underperforming great companies. This strategy is about expanding from great companies to potentially great ones. And when looking at most developing economies today, the number of “potentially great” companies is dramatically larger than the “great” ones. Also, the more value keys you have, the more companies of this type you can look at. In many ways, this strategy also just makes a lot more intuitive sense in developing economies—a developing companies value approach for developing economies.
I have mentioned several Waleed investments of this type. The George V, now Europe’s top hotel, required a $125 million refurbishment by renowned architect Pierre Yves Rochon and then a rebranding and repositioning through a management contract with the Four Seasons. The Savoy in London is currently undergoing a similar renovation. The Fairmont required a series of mergers and acquisitions to turn it into the world’s largest luxury hotel chain. More recently, Waleed’s 2007 purchase of distressed NAS airline is a “potentially great” play. NAS is one of the two private airline licensees in Saudi Arabia. It is well positioned to become a great company with some targeted political and operational help.
This is a pure value point strategy, as shown in Figure 12.3. We can target a truly large array of companies this way, and not only does it have a strong answer to the “What is my advantage?” question, it also handily takes care of most of the five going global problems.
Figure 12.3. Impact on potentially great companies
Recall also the section “B2B: Back to the Balance Sheet” in Chapter 3, “Value Point.” Potentially great companies expand us from Earnings Power Value (EPV) > Asset Value (AV) cases to those we assess to have EPV = AV and even those with EPV < AV, depending on the management and capability keys we can deploy. A politically connected company in a management-weak environment might well have EPV < AV and be a prime “potentially great” target company.
These previous two strategies are about hunting for deals at the intersection of developing and developed economies, at the points where the markets collide. They are also an expansion of the tools used—from capital and reputation in Strategy #2 to capabilities and political access in Strategy #3—and an expansion of traditional value investing to value point. The next three strategies are about moving from here into a committed global posture.
Strategy #4: Launch a Value Tank for Global Acquisition and Development Deals
Value tanks (focused value-adding vehicles) are stand-alone entities created to house specific value keys. The objective is a focused vehicle that, by virtue of its ability to add tremendous value, is able to roll comfortably across borders and geographies. The preceding chapters described examples of value tanks, such as Kingdom Zephyr in Africa and Kingdom Hotels in emerging markets. Note that although they are all value tanks, the translations can vary from public share purchases to illiquid private asset development to traditional private equity.
Private equity groups housed within investment banks, a fairly common situation in many developing economies, could also be considered an example. By buying shares in private companies in, say, China or India two to three years before they go public, these PE groups effectively warehouse the company within the investment bank for a later IPO. However, the important point is to note how the approach succeeds when traditional PE would not. Traditional PE looks for majority shares, an ability to use debt, and/or an ability to add management value. But these “pre-IPO value tanks” have a built-in value key—their investment banking businesses. Many rising companies would like to be taken public by Morgan Stanley or Goldman Sachs and see value in having an investor with such ties. The PE firms basically use a capability key (investment banking) to secure access to the deal and eliminate the risks of being in a minority position.
Another example is GE Money, which uses long-term added value to buy into public banks, retailers, and other companies across the world. Their preferred approach is to buy 10% to 20% of a public bank (typically $200–500 million) in a developing economy, such as Turkey, Eastern Europe, the Middle East, or India. At the same time, they do a development deal to plug their consumer finance products and capabilities into the bank’s platform. And as the bank shares are publicly traded, they rapidly increase in value with the new consumer finance products, as well as with the GE name. The GE Money approach is that of a particularly powerful value tank primarily using capability and reputable capital value keys.
In terms of the presented frameworks, value tanks can target good, potentially great, and great companies and any of the discussed market inefficiencies (cross-border inefficiencies, capability gaps, and so on). We’re both buying and building good to great companies, and the more value we can add when closing the deal, the greater our advantage, the more likely we are to get a cheap price, and the more attractive the investment economics. Again, we are dramatically expanding the circle of companies we can target with a long-term value approach.
This strategy is probably the most effective and accessible for Western-based investors, PE funds, value investors, and business development executives. It is a fairly easy step that leverages their current capabilities into direct global investments, while at the same time building up the political and other softer value keys along the way. Generally speaking, the stronger the capability keys built into the focused vehicle, the more easily the vehicle can roll across borders. It solves many of the going-global problems and tends to naturally make the investor into a “value-added partner of choice.”
Strategy #5: Build a “Direct Spectacular” Investment
This is the other “five value keys” approach I discussed in Chapter 10, “Global Tycoons, Value Tanks, and Other ‘Go for the Jugular’ Strategies.” We build as much value as possible into a single direct and spectacular investment, either locally or in an overseas location. These investments can result in large, rapid returns and the creation of a truly great company. These are the cruise missile analogs of value tanks. We are building one great company in one big move.
I have seen this strategy only in developing markets. However, it does often rely on bringing in developed-economy partners and capabilities, so it can have a cross-border component. You could characterize Middle Eastern mega real estate, Macau gaming, Chinese operating giants, and many of the other fairly eye-catching emerging-market phenomena as versions of “direct spectacular” investments.
Strategy #6: Buy or Build a “Bird on a Rhino” Investment in a High Growth Environment
In Chapter 10, I argued that sometimes it is mostly about the environment, that certain environments are more responsible for the attractive company financials than the company itself. I described Macau and Liujiazui as two examples.
A subset of such attractive environments is when separate economies become linked and experience rapid economic booms. The most spectacular “link surges” have been the explosive growth of Dubai and Macau. These small, shallow economies surged on the back of massive inflows of international customers and capital. The recent flood of mainland Chinese capital into Hong Kong real estate is another link-surge example. Saudi Arabia’s 2005–2006 real estate and stock market booms were the result of its link with the Western economies and oil reaching $100 per barrel. Certainly such rapid-growth situations create the opportunities for trading stocks, real estate, and other assets. But such attractive environments can also be approached with a longer-term value mindset that benefits from growth but does not depend on it.
The best approach I know for such environments is the “bird on a rhino” strategy described in Chapter 5, “How Political Access Adds Value.” Such situations almost always go hand in hand with the actions of the large corporate and government rhinos, particularly in shallow economies. Dubai’s boom was mostly created by the large state-backed companies. So we take advantage of the opportunity by buying or building smaller, highly scalable investments that directly benefit from the actions of these large companies (a bird on a rhino). The most direct method is to buy a smaller company and then sign revenue contracts with several rhinos. And although these booms can end quickly, and badly, if we focus on highly scalable businesses and come in at the right price, we can do very well in the long term.
This strategy is shown in Figure 12.4, but it can involve any combination of value keys.
Figure 12.4. Strategy #6: Buy or build a bird on a rhino in a high-growth environment
China’s outbound M&A activity over the past 2 years is a compelling example of a link surge. These cross-border deals have been primarily focused on acquiring natural resources in Africa, Australia, and Latin America; technology in Europe; and technology and distribution in the U.S. (more attempted than realized). If you have a company that benefits long-term from the trend shown in Figure 12.5, it is virtually impossible not to make money.
Figure 12.5. China’s outbound foreign direct investment (FDI)
In practice, such investments can be traditional value investing, value point, or PE. You can build, buy and hold, buy to sell, and so on. Within the next 5 years, we can anticipate many more of these link-surge opportunities, as they seem to be a natural occurrence in a colliding world. Figure 12.6 lays out the areas I am following at the current time, but it’s more for illustrative purposes than a detailed accounting.
Figure 12.6. Link-surge situations (illustrative)
Thus far, I have presented three strategies focused on the intersection of developed and developing markets and three focused on switching to a global posture. And with each one, the number and types of companies targetable with a long-term value approach have incrementally increased. The final three strategies are focused on direct hands-on investing deep within developing markets.
Strategy #7: Buy Small-Medium Private Companies in a Rising Environment
Several billion people are furnishing their first homes, taking their first cars to the garage, and discovering everything from over-priced lattes to luxury handbags. And similar to the West, most of this daily activity, by both consumers and companies, happens at small and medium-sized businesses.
In rising markets, rising small and medium companies offering local, regional, and national services and products are attractive investment targets. It turns out that the West’s most successful export has been entrepreneurial capitalism. You can basically pick any first- or second-tier city in any BRIC country and start discovering good businesses benefiting from attentive owner-managers, local economic development, and market growth. It is worth noting that in the first 6 months of 2010, while the West was still firmly in recession, more than 100 companies went public on Shenzhen’s new small-medium-sized company exchange.
Most of these small-medium companies are run by owner-managers and operate effectively as family-owned companies. They are hands-on, and they appreciate reputable investors who can help them move their business to the next level. In many cases, they are looking for longer-term smart capital as opposed to the relatively abundant local “hot” capital. In terms of deals, these are opportunities typically in the $10–40 million investment range, almost always for a minority equity stake. So it’s about creating a value-added partnership over time.
This is the value point equivalent of small cap stock picking, of scouring the world’s antique shops for mispriced situations. You are as likely to find such companies in Wuhan and Bangalore as in Shanghai and Mumbai. So this strategy is often about going well off the beaten path. Generally, you are looking for good, not necessarily great, companies that are significantly mispriced primarily because there are so many of them. Occasionally you’ll find a really good small franchise, but the strategy is mostly about getting a great price on a good company in an attractive environment. And these situations benefit from all sorts of investor biases and inattention. They are small companies. They are in developing markets. They are illiquid. They are minority shares. They are out of the way. However, as the population of companies of this size is quite large, you do have to dig a lot to find the gems.
The challenge with this approach is basically every problem listed at the start of the book: how to deal with the risks of a small, illiquid minority investment and how to proceed with a long-term value approach in an unstable, uncertain environment. But the main approach, adding value, can also be much more powerful in these smaller companies. It takes a particularly powerful approach to add significant economic value to a $150 million enterprise. But the $50 million range offers lots of options, particularly when capability keys can be deployed. So it’s mostly about becoming a valuable partner, particularly relative to often cash-rich, better-connected local investors.
This approach also works well with softer types of value-add, such as reputation, expertise, and capital. In this, it is similar to the competition you see between foreign and local PE firms in many emerging markets. How can a foreign PE firm like Kohlberg Kravis & Roberts (KKR) compete with a local PE firm like Industrial Credit and Investment Corporation of India (ICICI) Ventures in India? ICICI Ventures, which grew out of a large domestic bank with branches and corporate customers across the country, is able to position itself as a national provider of capital and a source of financing options. KKR smartly focuses more on building value-added relationships with entrepreneurs who are looking for more than just money. This approach becomes easier in more technical fields such as healthcare, technology, media, and oil and gas. A foreign investor with deep expertise in these fields can become a far more valuable partner than a local investor.
Another good example of an investor pursuing a hunt for mostly unrecognized value in unusual geographies is Tom Barrack, founder of Colony Capital. Barrack is also illustrative of someone going global successfully without a strong value-add (it’s tough to have a big non-political value-add in real estate). Colony Capital’s emerging market investments are much closer to standard value investing tageting undermined areas.
Barrack has been called the world’s greatest real estate investor. And as one of the West’s PE/real estate giants, he is well on his way to global tycoon status, having invested over $45 billion in 12,000 assets worldwide. He originally focused on U.S. real estate with a strategy he described as “cautious contrarianism” and the “exploitation of inefficiencies.” Eschewing “chasing the yield,” he generally focuses on identifying value that others do not see. And this approach, unsurprisingly, has led him to look at far-flung locations. He purchased 55% of Mars Entertainment, Turkey’s leading movie theater chain. He purchased 10% of Megaworld Corporation, a Manila development company. He has purchased private hospitals in Switzerland and pubs in the UK. And he famously purchased Japan’s Fukuoka Dome based on the value of the titanium in the roof. I also suspect that his global approach has something to do with the fact that he started his investment career working for Middle Eastern investors. I’m guessing this gave him a level of comfort in unusual locations early on.
Real estate is both the easiest and most difficult industry to go global in. It’s easy in that real estate globally is similar to real estate in the West. A building in Japan or Turkey is pretty similar to a building in Australia or Spain. And fixed assets tend to avoid many of the longer-term problems of operating assets in state capitalist or godfather systems. As mentioned, it’s easy to lose customers, products, or managers, but it’s hard to lose a building. If you can get the real estate deal done, you are 80% of the way home in terms of returns.
However, real estate is also the hardest industry for foreigners to add value or have an advantage. It’s just not that difficult to replicate the expertise. In countries such as China and Russia, local companies have built real estate expertise and possess better networks and deeper pockets. It’s hard for foreigners to have a substantial advantage that will overcome their disadvantages. In godfather economies such as Singapore and Qatar, real estate tends to be tightly held by the ruling family, and getting deals is difficult without political access. So Colony Capital’s going global is similar to the targeting of smaller private companies. You are hunting further afield where you either have an advantage or where you are looking at something others have not seen. In practice, it’s most often value investing with a little value point. So the best approach is to target regions that have little capital (real estate in the Philippines) or just a rising sea of undermined companies (small-medium private companies in the BRIC and GCC).
Strategy #8: Buy Cheap Companies in Environments or Situations That Others Avoid
At a low-enough price, everything is a good investment. Wherever I go, I always find it worthwhile to occasionally put aside my investment strategy and just take a look at the cheapest things I can find. Or if there is no clear price, I look for the asset that all the other investors avoid. A little hubris can sometimes go a long way.
An investment strategy based on avoided companies is well known and not discussed here. Hunting among small companies, bad industries, bankruptcies, and others is in many ways value investing at its purest.
Looking at the global landscape in this way today, three opportunities jump out. The first is distressed companies in weak management environments. I have argued that the most important capability migrating from developed to developing economies is management ability. And I have written a lot about dealing with hypercompetition and the often-intense competitive threats that can result from rapidly increasing management ability globally. However, the inverse of this situation is environments that have very little management ability. Central Asia, Western China, the Middle East-North Africa (MENA), and Africa have some very weak management regions. Weak is a somewhat harsh term to use, but the management ability of these regions is definitely several levels below that of advanced economies. And there can be a widespread lack of specialized skills, such as asset management, software development, or insurance underwriting.
A company organization chart in such a region usually shows a few very senior manager-owners and possibly one or two technically proficient advisors and then a large gap as it drops to lower-level administrative or clerical staff. Middle management and other skilled professionals (engineers, designers, underwriters, etc.) are few.
Meeting with potential partners in the Kingdom Holding office, my standard tactic was to give them a tour of the office (people always seem to want to know about Waleed’s Airbus 380). At the boardroom window, I would ask the potential partner to look down the 984 feet to the borders of the Kingdom property. You can see the manicured gardens, clean sidewalks, and well-designed layout. But looking across the street in any direction you see garbage, cracked sidewalks, ugly buildings, and fairly terrible businesses. My point being that even in the prime central business district, Kingdom Holding is literally an island of quality management.
In weak management environments, investors usually prefer fixed assets (mines, infrastructure, real estate) or fairly simple operational entities (retail stores, operations and maintenance companies, factories). A cement factory can sell in a few days in the Middle East. You can sell luxury apartments almost anywhere. But investors will stay far away from more technical operating companies, and they strenuously avoid distressed and operationally intensive turnaround situations. A historically leveraged buyout-focused company like KKR will have a hard time getting these deals in many developing economies. But a distressed-focused company like Cerberus will find itself the only bidder in deal after deal in many of these regions.
Distressed turnarounds in management-weak countries are situations where you can get a ridiculously low entry price. And you can find those attractive situations where AV is above EPV. So if you can impact management rapidly, not only do you get a quick jump in EPV relative to AV, but you can sometimes create a surprisingly sustainable competitive advantage in the market (ie., management). Much of the competitive theory assumes the presence of effective management in the market. I am continually surprised at how, in many markets, effective management is a really strong and durable competitive advantage in itself. And even in developing economies that have some management ability, there is still a strong preference by investors for development, not turnarounds. In high-growth markets, investors always seem to want to stay at the front of the development curve. It’s just more exciting, and there is much less interest in fixing broken businesses.
Turnarounds have an additional political and reputational dimension that can further limit competing bids. Distressed situations in godfather economies (Singapore, Hong Kong, Saudi Arabia) are often kept quiet and handled discreetly. They are discussed between families and are not floated for open bid. When I first met Prince Waleed, I recommended that he close his private hospital because it was taking operational losses and would be a very difficult turnaround given the immaturity of the country’s private healthcare system. He made it clear that because the hospital bore his name, there was no way he would ever close or sell it. Turnarounds can be those rare situations when even fairly powerful local investors can find themselves in weak positions. And to Waleed’s credit, he turned around the hospital. Kingdom Hospital Consulting Clinics is now arguably the highest-quality private medical group in the country.
Such distressed situations also seem endemic to developing economies. Things are being built very fast, and fairly regular market swings occur. Development can easily get ahead of actual demand. And although well-managed companies might survive the periodic market busts, the poorly managed ones collapse quickly. Weak management, rapid development, and highly volatile markets create a steady stream of distressed assets. If the U.S. stock market is a deep pool that continually presents mispriced companies, developing economies are advancing markets that continually leave behind distressed assets.
The “go after what others avoid” strategy in this context is to acquire the companies and improve the management in a surgical fashion. It’s buy and surgically fix. This typically means a rapid turnaround effort and/or a merger. One common approach is to put in a technical or management agreement with a Western company. If this can be done, it looks like a very low-priced value point investment. If it requires a longer-term turn-around effort, it starts to move outside the strategy.
A similar opportunity today is the avoided and ignored geographies of Africa and Central Asia (and several other places). Everyone is looking at Grade-A real estate in Shenzhen, but few investors are looking at Grade-B real estate in Mongolia. Tertiary hospitals in Bangalore and Mumbai are now overbuilt, but the second- and third-tier cities are underserved. There are lots of industries and geographies where you can be the only investor and can get a very low price—if you are willing to go to places others avoid.
A third very low-price opportunity today is avoided cross-border deals. If Africa is actively avoided by most investors, cross-border deals between places such as Africa and Russia are even more so. Most Russia investors think about Russia. Most Africa investors think about Africa. Obscure cross-border deals tend to be orphans.
I like to start business school courses with a game called Global Jeopardy in which I present the students with various leading global companies and investors and see if they can identify them. (Answer: Carlos Slim. Question: Who is the world’s richest person?) And because the class locations can vary between New York, London, Dubai, and Beijing, the contrasts between the students’ answers are interesting. European and Chinese students do OK. They can usually identify about half my list of leading companies and investors. Southeast Asian and Middle Eastern students are particularly good at this. American students do the worst. Their knowledge generally is limited to things that are American or maybe European. I find that the degree of someone’s international knowledge corresponds pretty closely to how many opportunities there are in one’s home market. It also tracks with how “foreign” an area is perceived to be. Whether it’s from lack of interest or comfort, there are quite a few places in the world today that nobody really knows much about or is paying much attention to.
Obscure cross-border situations offer these types of avoided and ignored opportunities, where you can be the only bidder and enter with a very low price. American investors are becoming increasingly comfortable doing deals with Chinese and Indian companies. But Russian and Brazilian companies are still very uncomfortable dealing with each other. My approach is to target inefficiencies that are both large dollars and very awkward and/or ignored (U.S.–Russia, India–Africa, Middle East–Southeast Asia). It also helps if there is already significant trade or other business occurring between the targeted regions.
An example of a company doing well with this approach is SinoLatin Capital, a Shanghai-based investment and advisory group, that was one of the first companies to target Latin American–Chinese resource deals. The consumption of Chinese natural resources is surging, and this is driving resource acquisitions in Latin America, among other places. This is the type of very big and very awkward cross-border deal situation we look for. How often do you see a trend like Figure 12.7 within a developed economy?
Figure 12.7. China’s percentage share of world commodity usage
Cross-border activity between China and Latin America, both M&A and direct investments, is as awkward and uncomfortable as you can imagine. Virtually no Chinese managers and professionals have experience in Latin America (or speak Spanish), and vice versa. There is a knowledge gap, a cultural gap, a language gap, a politico-economic gap, and a comfort gap. It’s the kind of situation that gets the value crowd excited.
SinoLatin’s approach is to capture the difference between the intrinsic value of mines and other Latin American resource assets, and their value to knowledgeable Chinese buyers (an emerging markets’ version of Mario Gabbelli). Deal structures are based on providing reputable capital (to overcome the lack of comfort and knowledge) and surgical management. As a trusted third party with respected management, they can purchase such assets, restructure them, and then sell them to Chinese state-owned enterprises (SOEs). With the right price, it is really pretty difficult to lose money in this sort of situation.
One cautionary note regarding avoided deals, cross-border orphans or others, is that the business strategy has to be compelling enough to overcome the difficulty in getting the deals done. The awkwardness is an opportunity to get a good price, but it also means that the parties are not terribly comfortable doing deals together. Is the business strategy and the investor’s reputation strong enough to get such people to actually sign? Or will they just meet and drink tea for 6 months? The reason awkward China–Africa deals now get done is because of China’s growing need for natural resources. Western development deals into China and India get done because of the multinationals’ need for high-growth markets. If your target is the avoided deals between the Middle East and Russia today, it will likely be difficult to find a compelling-enough business strategy (maybe oil and gas?) for large dollars to actually start moving. There can be lots of first-mover disadvantages with this approach.
In practice, avoided cross-border deals are mixed value investing-value point investments. They use the reputable capital and some political access value keys against very large inefficiencies. And they can easily be done by value investors, PE firms, entrepreneurs, and other groups.
Looking forward, I think the most attractive of these cross-border orphans will still be between the developed economies and the BRIC + GCC countries. Second to this, the interactions between the BRIC countries and other smaller emerging markets (Vietnam, Africa, Mexico) are becoming more interesting, particularly as BRIC companies start to go international. Figure 12.8 shows the trends and interactions I am keeping an eye on at the moment. Again, this chart is mostly illustrative.
Figure 12.8. Cross-border situations
Strategy #9: Structure Political Deals with Guaranteed Returns, or Buy Companies with Politically Limited Competition
Political access can effectively break the relationship between market forces and profits. Instead of profits and value following from a company’s performance within the competitive dynamics of a market, profits follow mostly from the actions of state actors.
As mentioned, government involvement distorts markets, both positively and negatively, for investors. It can create everything from politically mandated monopolies to hypercompetition, from frozen to excessive credit, and from a stable and predictable to a constantly shifting investment landscape. However, direct government involvement in specific projects and companies goes far beyond skewing the landscape and can directly, and overwhelmingly, impact profits (and intrinsic value).
In this sense, we can characterize an entire class of “political deals.” The traditional value investing form of this strategy is to simply buy companies that have politically limited competition. However, as one moves to hands-on, valued-added deal-making in such environments, this becomes a much larger class of deals. This can include securing contracts for the construction, maintenance, or management of government-run development projects, which can be very large in cash-rich developing countries. This can include building and maintaining airports or renovating schools and hospitals. It can be securing a bank or financial service license. It can be acquiring supplier contracts to large SOEs or cheap loans from state-owned banks.
This is usually the point where Western-based investors start to get uncomfortable. I don’t expect most readers to pursue this type of strategy, but I do want to highlight it as it is so common. If you ask an MBA in the U.S. how to become rich, he or she will probably tell you to become an entrepreneur or investor. Ask any Chinese MBA, and he or she will likely say, “Rise up in the government.” It is simply understood that the government and its state-owned vehicles are the largest players in the economy, so they are partners or players in just about every type of transaction. If you want to do telecommunications deals in China, these will absolutely depend on your relationships with the state-backed mobile companies and the government ministry.
In 2008, I attended a Middle East–China conference in Riyadh, where I was scheduled to speak near the end of the day (never a great time slot). Per protocol, a representative of the Royal Court was seated in a special front row and had been sitting there silently for the entire conference. By the time I spoke, various Asian and Middle Eastern industrial companies and professional services firms had given presentations, one after the next, about the historic silk road between the Middle East and Asia and the growing oil and gas trade.
Because I believe it is the duty of the afternoon speakers to wake people up a bit, I opened my talk by telling the crowd that I planned to spend my time giving a counterargument to almost everything previously said during the conference. I laid out the data to show why few MENA–China deals were happening and why Middle Eastern oil and gas and construction projects would not be going to Chinese firms any time soon.
I argued that the key to creating a real relationship between the regions and opening the door to investments was to focus not on construction or oil and gas, but on education, healthcare, power and water, and agriculture. I went on to detail how to incorporate Chinese nurses into Saudi hospitals, how to launch joint ventures in African farming and natural resources, and how to create cultural and educational projects between the regions. The key was to turn the unique Chinese capabilities and scale in these sectors into game-changers for long-standing Middle Eastern problems. At the end, the Royal Court representative stood and spoke for the first time during the conference, saying he had finally heard what he thought the way forward was.
This was a bit of a setup on my part. If you’re unfamiliar with Middle Eastern governments, you need to appreciate how many times each week for the past 30 years they have heard pitches from foreign companies wanting oil and gas allocations and parts of large development projects. The representative had probably heard those same speeches hundreds, if not thousands, of times. The truth is that Middle Eastern governments are good at oil and gas and development and have no real problems in those areas. You cannot add value there. Rather, their problems are in diversifying the private sector, improving healthcare, controlling food price inflation, and educating their workforce. If your objective is to add value, you speak to these issues. Then the deals and investments follow naturally. Value investing has traditionally been about understanding competitive dynamics. Value point in many places is about understanding political dynamics, as shown in Figure 12.9.
Figure 12.9. Strategy #9: Political deals
Previous chapters discussed some of Waleed’s early years (1978–1985), when he was primarily using political relationships at a point in time when the Saudi economy was almost entirely political. The combination of a highly political economy and the first Saudi oil boom created a situation where structuring value-added deals with the government enabled arguably the greatest moment of wealth creation in human history.
In the late 1970s and early 1980s, Saudi Arabia had only 9 million people and was experiencing an influx of approximately $130 billion in oil revenue each year. Given the government’s direct involvement in most industries, political access was the key skill for doing deals. Additionally, the country was relatively closed off, creating large cross-border inefficiencies. Structuring government contracts on one side, you could then contract or subcontract with operating firms internationally, capturing returns on both sides of the deal (in the range of 30%). Waleed’s first major contract was a construction project for a military academy, which he did as a joint venture with an ailing South Korean contractor. This was followed by a contract for a $70 million airport project. By 1981, his revenues had reached $1.5 billion, mostly from these types of deals. Over time, he expanded into operations and maintenance (someone has to maintain all those new government facilities) and real estate. The political and economic aspects of the environment have since cooled, and the country has opened up, but one can argue that Middle Eastern governments today have even larger problems. They are struggling with young populations and a need to diversify their economies; value-added investments and deals can speak to these issues and do very well.
Note: If you think political deals are purely a state capitalist or godfather capitalist phenomenon, you would be well advised to look at a few of the more reliably profitable American enterprises. Moody’s, S&P, and Fitch for years had been the only U.S. ratings agencies designated by the Securities and Exchange Commission as Nationally Recognized Statistical Ratings Organizations. Or investigate the executive salaries and accumulated real estate holdings at some of the larger nonprofits receiving various types of government support. Note that the SAT is administered exclusively by the College Board, a nonprofit with awesome cash flow. Or read David Einhorn’s book Fooling Some of the People All of the Time, a fascinating look at some of the interactions between government providers of credit, such as the Small Business Administration, and public companies, such as Allied Capital. How much government is involved in the economy in practice is a sliding scale, and staying in the purely private market areas is not necessarily the best strategy. Mr. Market and Mr. Government can equally create opportunities for value investors.
A final note regarding companies that have politically limited competition: Being one of two mobile service providers in Sichuan or the only outdoor signage company in Qatar can be very lucrative. Monopolies, oligopolies, and other limited-competition situations most often result from government actions (limiting the number of licenses, awarding exclusive contracts). For example, China has intentionally created limited-competition markets in automotive, telecommunications, and several other sectors. However, sometimes limited-competition situations are just the natural result of emerging markets. In many landscapes, both the markets and the competitors are still developing, and one or two companies just sort of end up in a strong position. If you get to Hainan first, you can buy a lot of the beachfront property. If you get to Bangalore first, you can own a lot of the outdoor advertising spaces. And these situations can often be found on a smaller scale and in places where few people are looking. Nobody really knows what’s going on in many parts of these chaotic, rapidly changing markets, and no one has any real control. Both too little and too much politics can create such situations.
In practice, these are mostly value point investments. Getting access is very, very difficult (people with monopolies usually don’t need cash or want to share). If these are government-created situations, they are, of course, fairly political: getting prime land, securing one of two licenses. If they are purely private, you need a large value-add to buy in. The dominant retailer in Western China won’t sell unless you bring significant value to the enterprise. And if they are simply unnoticed situations in emerging markets, you need to do development work to create a business that captures the oligopoly position. But the primary challenge is almost always getting access, and that means value point. Defensibility is also a big issue.
A final note on political deals. A politically focused strategy reflects the fact that government players are often dominant in an economy. However, this in no way implies or condones the fairly wide range of inappropriate and disreputable behavior that can occur at the intersection of government and commercial interests. Back to my earlier point, reputation is an investor’s most valuable asset. Regardless of the environment, I hold strictly to a strategy of creating value for my partners (government and commercial) and projects. I have found that this keeps one on an honorable path, even in murky environments. Any deal with significant political components should be able to be published in great detail on the front page of any newspaper without anyone having concerns.
A Multiprong Approach to Global Investing
Combining the nine strategies creates a robust going global approach
The presented global playbook constitutes a multiprong approach to global investing, as shown in Figure 12.10. And the nine strategies all support each other in practice. If you do traditional global value investing, value point makes this easier and vice versa. For example, value tanks create a very effective market entry approach, but also enable the building of direct spectacular investments. And both approaches can position the investor for traditional value investments or acquisitions of underperforming companies. All the strategies help each other, and the end result, which you can see in many of the world’s global tycoons today, is the ability to do direct long-term value investments almost anywhere in the world.
Figure 12.10. Developing economy opportunities
