13. After Markets Collide: The Next Twenty Years
The start of a new age can be confusing, and it’s often heralded not by grand pronouncements but by peculiar headlines. I challenge you to look at the Wall Street Journal on any given day and not notice a story or deal that strikes you as odd. Something you just wouldn’t have seen 10 years ago. A Chinese state-owned company is trying to buy Unocal? Indian Reliance is buying U.S. shale assets? Tom Barrack is buying the largest movie theater chain in Turkey? In ways large and small, a new investment landscape has arrived. And this is posing serious questions for value investors.
I never had the opportunity to meet Ben Graham, and I have taken quite a few liberties in using his work as a framework for addressing these questions. This is presumptuous, and I hope my method of looking at various environments through his frameworks is not taken as anything but the highest respect. My best guess is that Graham would have found global investing as thrilling and fascinating as most of us do. It’s profitable, and there’s plenty of room for ambition. It’s also an opportunity to understand many new things about investing, business, and life. The satisfaction is equally in the money and the adventure. Global investing is ultimately about bending your brain against a fundamentally changing reality—and particularly its sea of new uncertainties. Paraphrasing Frank Herbert, knowledge is the adventure that lives at the edge of uncertainty.
My objective has been to gently push you a little out of your comfort zone. If you are a traditional value investor, whether operating globally or not, I am arguing that you need to start thinking more in terms of negotiated deals. If you are in private equity, I am arguing that you need to start doing a bit of business development. If you are a business development executive, you need to start thinking like a surgical value investor. In all cases, I am not suggesting that you change your profession, but that you extend your methodology by about 20%.
If you do, I think you will discover that your opportunities expand exponentially. Suddenly attractive and capturable investments are everywhere, and you can walk comfortably and confidently across most parts of the world. We are the first generation of investors to really have the entire world as our playing field—and it is shame not to be out playing on it.
For global investors, the 2009 financial crisis was the official firing of the starter’s pistol. Pre-crisis, there were certainly lots of good global deals, but they were overwhelmingly the result of inbound development into the still relatively small BRIC countries and some turbulent interactions in the global financial system. Post-crisis, we have finally arrived in a multipolar economy—defined by multiple full-fledged economies with differing politico-economic systems and constantly shifting interactions. It is noteworthy that China was the first economy to recover from the financial crisis. And most importantly, we now have a critical mass of companies and professionals in every geography. Investors and deal-makers from all over the world are now meeting and exploring the deals and investments now possible. The result is a global investing gold rush.
This last chapter is about the next 20 years—what to do post-collision. I detail what various professionals are doing, and what I humbly suggest what many could be doing. If you have aspirations of going global, these are my recommendations for your next steps.
The New Wall Street
Investors and deal-makers from around the world are starting to meet
In 2009, I found myself sitting at a conference speakers’ dinner in Cambridge. The conversation on my right was about the likelihood of Dubai’s defaulting on its debt (one of my better predictions). The conversation on my left was about how Moscow lawyers had extracted what can only be described as government-supported hit men from a Qatar jail. From there the conversation swung wildly between surging Chinese acquisitions in Hong Kong, falling UK real estate prices (now being targeted by Middle Eastern groups), New York bank acquisitions, and Eastern European consumer finance opportunities.
It was the second annual Cross-Border M&A and Investment conference. As I looked around the room, the assortment of speakers was unusual by any measure. There were Western investment, banking, and legal leaders such as Peter Clarke (group executive, Man Group in UK), Richard Gnodde (co-CEO, Goldman Sachs International), and Martin Lipton (partner, Wachtell, Lipton, Rosen, & Katz). There were prominent Asian leaders such as Jiang Jianqing (chairman, Industrial Commercial Bank of China) and Richard Li (chairman, PCCW in Hong Kong). There were Western trade ministers, Russian lawyers, Japanese development bank officials, Beijing government M&A officials, Indian PE professionals, and pharmaceutical and industrial acquisition specialists. It was one of those odd experiences that gets flagged in the brain as being symbolic of something.
I decided that a significant point had been reached and that we are really at the beginning of something new. The world’s markets have collided, and now a critical mass of professionals, companies, and opportunities exists in virtually every geography. And we were all just starting to meet and explore the new possibilities.
It seems reminiscent of the first meetings on Wall Street in the 1790s. Traders and investors would come to Wall Street and, having nowhere to meet, would talk under a buttonwood tree. They didn’t have fixed investment structures and didn’t quite know how things would play out, but they were starting to meet and talk. This eventually resulted in the Buttonwood agreement, signed at 68 Wall Street on May 17, 1792, which gave rise to the New York Stock Exchange.
A similar event seems to be happening today. A new global Wall Street is being assembled. We don’t know each other that well yet. We don’t exactly know where all this is going. But we are all meeting (we prefer bars to buttonwood trees) and putting together deals. I fully suspect the next decade will go down as a golden age of global investing.
How to Become a Global Tycoon
Value investment giants, private equity kings, industry moguls, and other lords of finance are evolving into global tycoons
There is something truly spectacular about Waleed’s hotel investments, and it is worth standing in awe of it for a moment. His hotel footprint now covers virtually every major city in the world. Through direct and indirect ownership, he has stakes in over 200 hotels and resorts. And he built it all from scratch in less than 20 years.
Waleed almost always has a hotel transaction going on somewhere in the world. In the Middle East, it might be building a Four Seasons Hotel in Riyadh or designing Four Seasons branded service apartments into luxury real estate developments. It might be a greenfield development, such as the Movenpick in Beirut. In Kenya, it might be buying or building additional Fairmont hotels. The hotel investment strategy itself is actually fairly flexible. It can be standard acquisitions. It can be greenfield developments. It can be an acquisition with extensive renovation. And deals can also be occurring at the management company level, purchasing hotel companies and orchestrating mergers, such as the Fairmont-Raffles merger in 2006.
Waleed and his hotels are something new in the world. Proof that one person in one lifetime can create a personal empire that circles the globe. That a single investor, like the British Empire of old, can create an empire on which the sun never sets. This is particularly exciting for investors and financiers, who, already soaked in ambition, can now raise their sights and become even more ambitious. Why be just a lord of finance when you can be a global tycoon? You can now have assets and investments on every continent and can spend your days traveling within your own personal global empire. Waleed is probably the first pure investor to reach global tycoon status, traveling the world and staying in his own luxury hotels everywhere he goes.
Waleed’s investments have been described at length. And his insane V-speed is usually detailed in every article written about him. I have yet to meet anyone who can match his pace for more than a week or two. Figures 13.1, 13.2, and 13.3 are my summary of the evolution of his investment strategies over his 30-year career. He might not agree with it, so this should only be considered a possible “how-to guide” for becoming a global tycoon.
Figure 13.1. Stage 1: Political deals in high-growth, government-infused markets
Figure 13.2. Stage 2: Domestic and cross-border acquisitions of underpriced and underperforming assets
Figure 13.3. Stage 3: Global value-added investing and deal-making
Value Investors Should Go Global
Traditional value investors can easily and comfortably expand into multiple, complementary, global strategies
A colliding world is primarily a value opportunity. While the growth rates are impressive, the mispricings are even more so. Therefore, the primary approach of this book and the primary recommendation to investors is to expand traditional value approaches into a broader effort to target the inefficiencies inherent in a colliding age.
In terms of next steps, the investment strategies presented in the previous chapter are a logical step-wise progression to expand into global opportunities. The end result is the multiprong approach shown in Figure 12.10 in the previous chapter.
Buffett’s first major China investment was in the public shares of PetroChina in 2002–2003 (Strategy #1). His second major China investment was through a negotiated purchase of 10% of BYD (Strategy #2). Any Western-based value investor could easily go global by simply expanding within these first two strategies. And from there, a natural and comfortable next step would be to target potentially great companies and leverage in Western assets (expand to Strategy #3) or to launch a focused vehicle with a surgical value-add approach (expand to Strategy #4)—and so on down the list—the end result being a full multiprong global investment approach. And this could all be done comfortably and confidently from a single office anywhere in the world with only a handful of people. The strategy is global, but the method remains focused and surgical.
Business Development Executives Are the Uncrowned Princes of Global Investing
Corporate executives are well positioned to expand their capabilities into global investing
Business development for Western companies has traditionally meant capturing new products and services, acquiring capabilities, or finding ways to expand markets. Genentech acquires biotech start-ups to expand its product pipeline. American Express might acquire an Internet company to expand its online and e-business capabilities, a very lucrative consulting sector in the late 1990s. Kaiser does hospital deals to expand geographically from California to Washington, DC. And In-N-Out Burger, America’s much-loved corporate recluse, has finally, after 60 years, expanded from Southern California to Arizona and Nevada (coming in 2050 to a town near you).
But such business development activities have overwhelmingly occurred within developed geographies and economies, particularly for medium-sized and small companies. And deals are almost always driven by strategic and competitive considerations, not strict investment returns. A technology is needed. A market entry approach is needed. It’s part of a vertical or horizontal consolidation strategy.
However, more and more corporate executives are finding themselves in strong investment positions globally. As the great migration of capabilities continues, executives have found themselves holding valuable capabilities (value keys). Much of value point is about a mild blurring of lines between business development and investment strategy. Investors are starting to think beyond price and valuation, and more in terms of business strategy and adding capabilities (“buy and sell” plus “build and fix”). And business development and other corporate executives are starting to think more like investors. If my technology will increase the value of this private Indian company, and the company is eager to have me as a partner, shouldn’t I buy in?
Recall the previous discussion of GE Money as a value tank. They are one of the most effective groups at combining business development with direct investing around the world. They also have the advantage of sitting on an already global corporate platform and of having technology capabilities that are particularly valuable and transportable.
Consumer finance is also one of the more attractive industries in terms of emerging market economics, and GE Money has three powerful capability keys to use in constructing investments in this space. The first is sales and marketing/customer service expertise related to credit cards, mortgages, car loans, and other consumer finance products. They have hundreds of staff globally who are experts at increasing sales force effectiveness, determining pricing, building Internet capabilities, and mining customer relationship management (CRM) data. If a local Turkish bank can supply the customer list, GE Money can process and manage the rollout of consumer finance products to this group.
Their second capability key is risk management, which is obviously critical for offering consumer finance products in unusual locations. GE Money’s more than 15,000 risk and collections professionals can analyze the risk of consumer finance products at any local bank. In practice, this is a combination of data analysis, portfolio modeling, portfolio monitoring, and setting policies and terms.
Their third capability key is technology and systems, always GE’s biggest strength. This includes everything from software applications and databases to cellular banking platforms. By linking a local banking or retail operation with their global IT team, GE can offer a level of technical expertise effectively unmatched in any developing economy. This also creates a strong foreign value key, because such deep technical infrastructure cannot be easily replicated or localized.
These valuable, and nicely scalable and transportable, capabilities can be leveraged into direct investments. Note the power of this approach when compared to standard PE or value investing. In deals, they can add large value and can be comfortable taking only a 10% to 20% minority share of companies. It is also telling that in 2008, GE Money, much to the consternation of several U.S. Congressmen, moved their headquarters from Connecticut to London, which is a much more convenient location from which to do global deals.
In terms of the presented playbook, business development executives are very well positioned to go global by Strategy #3 (Buy a Potentially Great Company and Make It Great), Strategy #4 (Launch a Value Tank), or Strategy #5 (Build a Direct Spectacular Investment). All three of these strategies leverage in the capabilities these executives have access to. Of the three, launching a value tank (#4) is likely the most comfortable first step as it creates a full structure for developing investments.
Luxury brands and retail operations are another interesting “business development into direct investing” opportunity. It can be a very attractive strategy within this industry, if you can get it right. Unfortunately, Marks & Spencer’s flagship Shanghai store has, whether fairly or unfairly, become the symbol for getting it wrong. Launched on Nanjing Xi Lu, down the street from my home, the Shanghai store at opening was as bad as the press gleefully proclaimed it was. It was ugly. The products seemed geared toward foreigners in terms of prices, tastes, and sizes. And it was just a really unpleasant store to be in. Additionally, my favorite Starbucks was demolished during construction, so I feel some personal resentment there. But apart from the operational problems, which are quickly being addressed, and my own pettiness, it was also a very difficult strategy and a problematic structure for a direct investment.
A Western retailer going direct by launching a flagship store in Shanghai today has a somewhat low chance of success from an investment perspective. Retail in China is ruthlessly competitive, and the key step is getting land and/or retail locations—and foreign groups typically are at a disadvantage in this. Going direct into one location in Shanghai today means a lot of challenges and no clear, overwhelming advantage.
The key is to have the right “business development into direct investment” approach. Marks and Spencer, and most other large retailers and luxury companies, are actually in a fairly strong position to do such cross-border investments today. A value-added approach would be to enter by building strategic partnerships around the operating capabilities and thereby compensate for a weak ability to acquire sites. You want to think like an investor and both build a strong deal advantage and capture the economic value of the enterprise (and if possible the ancillary real estate). Basically, you want to play to your strengths and extend your operating and brand advantages to compensate for your weaknesses.
For retailers such as Marks & Spencer and luxury brands such as Polo Ralph Lauren, the most effective approach I have seen is to do Strategy #4 (Launch a Value Tank) and use a hybrid structure. The foreign company creates a wholly owned vehicle, which maintains ownership of the key capabilities (luxury capabilities can be fairly intangible). Then the company does joint ventures for the fixed assets such as the stores and real estate. The wholly owned company oversees marketing, merchandising, supply chain, and, most importantly, customer care. But the joint ventures give you local strategic partners, strengthen your political access, and let you capture the real estate investment returns.
For example, a top branded retailer such as Saks Fifth Avenue with an interest in China can create a wholly owned vehicle in Hong Kong that houses all the critical operating functions. This is traditional business development going into a new market. The retailer then creates a series of real estate joint ventures in second-tier cities, such as Hangzhou, Chongqing, and Dalian. Saks owns the operating company and directly invests in the real estate assets, which are contracted with the wholly owned vehicle. According to the value approach, this sort of hybrid structure has six main benefits:
• You maintain your key advantages (brand, customer base, sourcing) in your own vehicle thereby addressing the long-term downside uncertainties.
• You maintain ownership of the higher ROE vehicle, which is where much of the economic value per share will be created.
• The local joint ventures overcome the problems of acquiring locations and getting political access.
• You can raise local funding for the local assets, which have lower ROEs and are more exposed to market downturns, but which are also at less risk from a weakened claim to the enterprise-perspective.
• You can launch multiple stores immediately in multiple cities without financial risk.
• You can often capture the increased value of the ancillary real estate, which provides larger near-term returns.
In practice, it looks a lot like the Coca-Cola case. Once you begin mixing business development with direct investing, you have a lot of room for such creativity. You have more lines of attack than simply expanding the margin of safety with a low price. Structures and terms can be put together to solve the problems with access, uncertainty, claim to the asset, and foreigner disadvantages.
Private Equity as the Value-Added Partner of Choice
Global private equity can amplify structured transactions with deeper partnerships
If business development executives are thinking more like investors, PE firms are thinking more like business development executives. As detailed previously, the approach of looking for leveraged buyouts globally hasn’t been that successful. There aren’t that many suitable candidates, debt options are limited, and you rarely have the governance structure you need. It also misses the bigger story of the developing economies, which is development.
Pure growth equity similarly has its own challenges—the biggest being that lots of local capital is already hunting for and usually overpaying for growth. Arguing that you are “higher quality capital” is possible but difficult. This leaves globally ambitious PE firms with the conundrum of how to access attractive deals without their debt tools and with some natural disadvantages relative to overpaying local capital. As local PE firms increasingly focus on doing larger and larger fast transactions, most foreign PE firms are increasingly thinking about how they can add value to an enterprise. How can I help an entrepreneur in Mumbai? Or a family office in Qatar? How can I help a Chinese firm trying to enter the United States? If value investors such as Warren Buffett strive to be seen as the “buyer of choice,” PE firms going global are more and more striving to be seen as a “value-added partner of choice.”
This value-added partner of choice approach works quite well when going global and has multiple variations. It can be adding very tangible capabilities, similar to GE Money. Or it can be providing intangible value such as expertise and connections. But you’ll know it when you achieve it, because the doors to private deals will open in your field. In terms of the playbook, PE firms do well going global with Strategy #2 (Buy a Great Company on its Knees), Strategy #3 (Buy a “Potentially Great” Company and Make it Great), Strategy #6 (Bird-on-a-Rhino), and Strategy #7 (Buy Small-Medium Private Companies in Attractive Environments). For larger firms, Strategies #2 and #3 work well. For smaller firms, Strategies #6 and #7 are often more appropriate.
In Chapter 12, I described the competition between KKR and ICICI Ventures in India. ICICI Ventures generally positions itself as a provider of private capital and financial products to a wide national network. They focus on securing majority positions, LBOs (you can’t do an LBO in India, but you can do equity and then a loan later), and large effectively controlling minority positions. They mostly stay at the Board level and watch the financials while avoiding active involvement in management. The strategy is to stay transactional and deploy as much capital as possible, operating like a big CFO. Since the launch of their first PE fund in 2003, ICICI has expanded quickly to real estate and now infrastructure. We see similar local PE approaches across the developing economies.
KKR’s position as a value-added partner of choice for entrepreneurs and owner-managers is a natural contrast to this. They do deals that are far closer to foreign direct investment (FDI) than LBO. The key question with this approach is how much value to add, and how tangible will it be. Additionally, it helps to focus on industry sectors with greater technical or cross-border components, where expertise will be seen as more valuable.
A PE firm that has always been global and uses this approach effectively is Investcorp. Founded in 1982 to facilitate the flow of Gulf capital into Western PE investments, Investcorp’s strategy stands out as a contrast to the standard PE strategies within the U.S. Instead of having a geographically focused strategy, Investcorp has opened offices in Bahrain, London, and New York. Instead of having an industry strategy such as Welsh Carson in healthcare, Investcorp works across all industries. Instead of focusing on LBOs or growth equity, it does PE, real estate, hedge funds, venture capital, and GCC development.
Investcorp succeeds in this because it has created a bridge between GCC capital and Western investments, a long-standing cross-border inefficiency. Although one could say that Investcorp is not as competitive at the deal level (a U.S. healthcare growth equity deal will likely go to Welsh Carson over Investcorp), they are very competitive at fund-raising in the GCC and have captured a very secure long-term capital position. Sometimes being a value-added partner means adding value on the capital side.
Accelerating Out of the Downturn
Everyone else should reposition and hit the gas
A final group to consider is the catchall category of developed- and developing-economy family offices and smaller investment firms. Many of these groups are now considering global investing for the first time. And as the great credit crisis recedes, my recommendation to most is to reposition and accelerate.
I find that smaller investment firms in the Middle East and Singapore are good models for family offices and small firms thinking of going global. They have been crossing borders the longest, having always had more cash than local opportunities. They usually don’t have the extensive assets and long reach of large investment houses, multinationals, or PE firms. And they are geographically agnostic, usually equally willing to consider the U.S., Europe, and Asia. For family offices and smaller investment firms in the West, they are a very instructive group to watch.
For most Middle Eastern firms, the recent financial crisis hit like a shock wave from the West. The first wave produced large losses in their Western portfolios, against which many had borrowed locally. The second wave decreased demand for local products and services. It was this second wave that collapsed Dubai. The rapid disappearance of Western and Russian tourists and homebuyers shrank its income statement at the same time its debt ratio was soaring on its balance sheet.
Now post-crisis and looking at a changing world with wiser eyes, Middle Eastern investors are rapidly repositioning, some out of desperation. With large losses in the West and the dreams of Dubai shattered, most have gone back to basics and refocused on where the best opportunities are in the world today. They are now beginning to rapidly accelerate out of the downturn. In terms of the playbook, most are focusing on Strategy #6 (Bird-on-a-Rhino) and Strategy #7 (Small-Medium Private Companies in Attractive Environments).
Keep in mind, the prototypical Middle Eastern or Singaporean family office has traditionally relied on a few cash-producing domestic businesses (construction, logistics, ports, retail, cement, etc.) and has fairly limited management and capabilities. They are now refocusing on these core competencies and businesses and actively pruning their international ventures. For Saudi family offices, projects started in secondary geographies such as Egypt or Jordan are being dropped. Previous visions of regional dominance are no longer compelling. Back to basics is about going back to situations where strong advantages for deals exist. But it’s also about speeding up. At the same time they are withdrawing from Jordan, they are expanding to Singapore and other parts of Southeast Asia.
This family offices going back-to-basics phenomenon has some important lessons for Western family offices and smaller investors going global. It’s a reminder that most of the cash-producing businesses in developing economies are concentrated in a few core industries. In the GCC, it is businesses that track government spending and oil wealth (banking, real estate, petrochemicals). In Asia, it is businesses that track growth (construction, logistics, infrastructure, banking) and manufacturing. And this is a clear rebuttal of the approach of grouping several developing economies under a regional strategy. It’s a reminder to go focused and surgical in a big world—and to increasingly specialize, particularly in technical fields where large advantages and value-adds can be deployed.
Dedicated to the Skeptical Optimists
Summing up, what a global investment world really needs is more of Graham’s disciples
At the start of this book, I postulated that Graham’s work is so widespread because it has a deeper impact on readers than just showing a consistently profitable investment strategy. It speaks powerfully to the other seemingly inherent characteristics of a value personality. The value crowd is highly rational. They are logical. They have a deep respect for the inherent uncertainties of a complex reality. And many of us are perpetually restless and endlessly curious. Graham’s work fits our worldview, but it also fits our personality.
Within the value temperament, there is an almost visceral gut reaction to hyped trends, stories of easy riches, rosy future predictions, and other oversimplifications of complex systems. If we have a deep respect for the inherent complexity of the world on one hand, we have a healthy disdain for the tendency of the human brain to seek simplistic patterns and causal relationships within it on the other.
Skepticism runs deep within Graham’s fans. We are usually polite but merciless when presented with faulty logic, weak data, optimistic business plans, and overly predictive models. The truth of things is very rare to find, and killing off the weak ideas and the bad investments is the only way to get there. Our fairly deeply entrenched skepticism follows from a belief that most things are complicated and we, as pattern-seeking mammals, are particularly susceptible to pretty PowerPoints.
You’ll note that much of this book has focused on describing the most difficult situations and investigating low probability events. Yes, many foreign strategic investors will lose control of their businesses in Russia and China (this is not the same thing as losing money). Managers will abruptly quit. Governments will change their policies. Emerging markets won’t emerge—at least, not fast enough for your financing plan. You will discover corruption and theft hidden in your company. Credit will get pulled. And government officials will threaten to revoke your license if you don’t agree to refurnish their homes (true story). I realize this can all read pessimistic.
But such skepticism is not pessimism. After you discover all the problems, strip out the inaccuracies and uncertainties, and mercilessly shoot down the weak ideas, you ultimately are left with the truth—and the really good investments. You can then confidently make money and achieve a real bottom-up understanding of the world as it is. There is something both optimistic and inspiring about this process. About the power of a few stubborn people to slowly and doggedly get to the truth of things. I have found that the skepticism and the optimism go hand in hand.
My hope is that this book will convey an optimism about investing and life at a time of historic change. Previous generations of investors never got to have this much fun. And as the investors and deal-makers on the ground and in the trenches, we are getting front-row seats to possibly the most transformative decade in human history. This is a truly great time for Graham’s disciples.
So this book is dedicated to the brutally skeptical but deeply optimistic value crowd—the ornery shorts, the combative analysts, the infuriatingly difficult researchers who just won’t take your word for it, and all the other curious characters whose craft is skeptical inquiry. What the global investment landscape really needs today is more of you.