Would Billy Beane like Cymbria? – 1st quarter, 2018
“People are always blaming their circumstances for what they are. I don't believe in circumstances. The people who get on in this world are the people who get up and look for the circumstances they want, and if they can't find them, make them.”
─ George Bernard Shaw, Mrs. Warren's Profession
I recently watched the movie Moneyball with my son. The reason I wanted him to see it had nothing to do with baseball and everything to do with great life lessons. At the heart of the story is Billy Beane, general manager of the Oakland A’s – a small-market team with a limited budget that has just lost three star players to free agency and needs to overcome significant obstacles to build a winning franchise. To accomplish this goal, Beane realizes he needs to do something unconventional. He hires a young Yale economics graduate, Paul DePodesta, who evaluates players using statistical measures that hadn’t traditionally mattered to baseball scouts and managers. Beane goes all in on this new approach and as the season progresses faces reproach from his scouts, on-field manager and the media. It’s obvious doubt creeps in for both Beane and DePodesta at times and the movie exudes all the tension and anxiety swirling around Beane as he’s left to dangle in the wind.
Beane sticks with his revolutionary approach and in the second half of the 2002 season achieves success with an American League record 20-game winning streak and a first place division finish. Because Beane upsets baseball’s establishment by breaking with tradition, he’s not given credit for the success. The media instead focuses on the field manager, Art Howe, and individual player effort. The movie includes many important life lessons (as does the book, Moneyball: The Art Of Winning An Unfair Game) but to me the core message is to live your life fully and without regret by adapting to what it gives you and creating your own circumstances. This is something I try to instill in my children every day.
While compromise is often critical in life, there are times when being uncompromising is integral to long-term success. Our approach to investing is uncompromising. Our belief in it stems from the many years it has achieved superior investment returns. We’ve no doubt there will be times when it doesn’t work as well as other investment approaches. Achieving superior investment returns every day, month, quarter or year is an unattainable goal so probably not worth chasing. What’s more easily attainable is having an investment process that we’re confident in, apply every day and that we believe will lead to superior investment results over a ten-year period.
There’s great synchronicity in the way Beane builds a baseball team and how we manage your money. Our approach leads to our investment results and whether the stock market is going up, down or sideways, it’s what we believe will lead to superior long-term investment results. The investment process is all that matters to your investment with Cymbria. Let’s look at some examples of the commonalities.
The opportunity in others’ biased judgements. Or, you look funny – I like the other person better!
We search the world for the best 30 to 35 investments out of a pool of over 50,000* publicly traded companies globally. Meaning only a select few will ever make it in. We have strict criteria for these businesses. They must be well-managed, have a durable competitive advantage and be available at a reasonable valuation relative to their true economic profit or free cash flow, today and in the future.
Much like Billy Beane putting together a baseball team, building a stock portfolio at Cymbria isn’t a beauty contest. We believe that investing simply based on surface attraction will eventually only lead to harm. We look below the surface of a business for strengths that aren’t evident.
In the movie, DePodesta flags pitcher Chad Bradford as being affordable at the time for the A’s because he has a funny throw that other teams are put off by. Finding value in a business rarely comes without a significant number of investors believing that the business is somehow flawed. People prefer simple, clear options to complex or ambiguous ones. The problem with clear and simple choices in the stock market, as in baseball, is that you often pay a high price for the comfort of clarity. We’d rather delve into the complex and ambiguous option to see whether the perceived flaw matters to the future of the business or if it’s just human bias towards the seemingly attractive option.
I’ve discredited the following perceived flaws in businesses which led to an investment for Cymbria:
The CEO was unusual
The business was managed in an atypical fashion
There was a competitive threat that would cause significant damage to the company’s profitability
The company’s products weren’t good
The business is mature and wouldn’t continue to grow and prosper in the future
Any of these can lead to a business being underpriced by the market.
At the same time, it’s not enough to look at a company simply because there’s a perceived bias making the company statistically cheap. We’ve no interest in being contrary simply for the sake of it. We need to understand the biases and determine whether they’re actually accurate, because often a business that’s statistically cheap is so for good reason. Doing thorough research into different perspectives is the path we take to establish some clarity. Here’s an example of one of the “Chad Bradford’s” you’ve had in your investment portfolio.
In November 2017, we invested in Bioverativ. It’s a biopharmaceutical company that researches, develops and commercializes hematological therapies.
We knew Bioverativ before we invested because we already held Swedish Orphan Biovitrum (SOBI), Bioverativ’s partner in developing products for hemophilia, and at the time believed it was the better investment.
The perceived bias against both companies was the competitive threat from revolutionary products using gene therapy and other unconventional methods. We were skeptical because historically these unconventional therapies have caused serious diseases, like leukemia, in hemophilia patients with other conditions. Sure, some believed that gene therapy had improved but I probably wouldn’t switch to something that had no long-term safety record and had caused cancer when SOBI and Bioverativ already offered safe and effective products.
The other perceived competitive threat came from Swiss drug maker Roche’s new therapy, Hemlibra. Roche is an industry giant and has had great success developing new drugs so it made no sense to simply dismiss the threat from this Swiss beauty.
While I was skeptical about Roche’s competitive threat, many other investors weren’t, leading to an almost 20% decline in Bioverativ’s stock from late October through December 2017 after Roche published clinical trial results for Hemlibra. About the same time as Bioverativ’s stock was declining, the U.S. congress passed new tax laws that reduced Bioverativ’s tax rate from 36% to around 20% leading to a significant increase in its free cash flow. Using reasonable growth assumptions, we believed we were acquiring Bioverativ at 10 times its 2018 free cash flow. This is a very low valuation relative to other growing biotechnology stocks. Bioverativ’s valuation was low even though it was expecting continued high revenue growth well into the future.
Our skepticism about the competitive threat to Bioverativ may be valid as the large French pharmaceutical firm, Sanofi, bid $11.6 billion for Bioverativ this January. Sanofi is also developing a new hemophilia treatment, Fitusiran. Regardless, Sanofi seems to believe there’s significant value in Bioverativ and SOBI’s version.
Amazingly, the bias against the strength of SOBI/Bioverativ’s hemophilia treatments appears to remain. Even after Sanofi’s bid to acquire Bioverativ, SOBI continues to trade at 39% of the value that Sanofi was willing to pay for Bioverativ! Time will tell but I believe the bias against SOBI will also diminish and it too will be a great investment like Bioverativ. It’s surprising to me that even when Sanofi, with deep industry knowledge, finds an asset like Bioverativ attractive, investors continue to dismiss SOBI as equally attractive.
In Moneyball, John Henry, owner of the Red Sox empathizes with Billy Beane over the beating he gets from the baseball world for his statistical rather than intuitive approach to managing his team. Henry offers to make Beane the most highly paid general manager of any sport in the world. Beane ultimately rejects the offer and goes back to his job with the A’s, earning just a tenth of what the Red Sox would pay him. And he manages the A’s with less than half of the Red Sox’s 2003 payroll. When asked why he didn’t take the job, Beane replies that he only made one decision in life over money and regretted it. Besides being closer to his daughter, I often wonder if another reason he stayed with the A’s was because applying the ‘Moneyball approach’ to a team with money would have been less challenging. Call me crazy, and maybe it’s a romantic notion, but winning the World Series with a big payroll is kind of cheating and a bit of an empty achievement. While we don’t know the exact reasons, it’s pretty clear that Beane loves his job and doesn’t do it for the money.
I consider myself very fortunate to be in the minority of people who love their job. Probably the most excitement I get at work is when I come across a company that’s innovative, entrepreneurial and led by its founder who’s also a shareholder. This type of leader is often disruptive, threatening the status quo in their industry in much the same way as Billy Beane in baseball. Sometimes they’re glorified and other times vilified, but always they’re viewed as being different. I guess if you’re crazy enough to believe you can change the world, chances are pretty good that you’re going to be perceived as a misfit or troublemaker.
One investment in Cymbria that fits this description is Ubiquiti Networks. After working at Apple, Founder and CEO Robert Pera started the company in 2005 with $30,000 in friends and family money and credit card debt. This year the company expects to generate over $1 billion in revenue from a standing start 13 years ago. Ubiquiti has two businesses. The first is providing wireless communications equipment to wireless internet service providers (WISPs). WISPs provide internet service to customers in rural or remote areas. The other business services small-to-medium sized enterprise customers with networking equipment including switches, routers and WiFi access points. The company is now introducing high-end products to service large enterprise customers, so far with modest success. Given the quality and price of its products, we believe that it will continue to chip away at the market share of companies like Cisco Systems. It’s a substantial opportunity at about $20 billion. With Ubiquiti currently doing a little over $500 million in the enterprise business, there’s a long runway for growth.
Pera is an unconventional CEO to say the least. Ubiquiti has a decentralized operating structure with engineering groups worldwide. He refers to the Chief Financial Officer as the “Chief Accounting Officer” because he believes too many CFOs are overly focused on marketing rather than finances. It may seem like semantics, but clearly he’s uncompromising. He pays himself $1 a year and has never taken incentive stock compensation. Ubiquiti’s products are innovative and technologically strong, though it sells them at a 50% to 60% discount to drive growth and market share. It accomplishes this by having no sales or support team, choosing instead to service its clients online. Its Board has just four members to meet the regulatory minimum, making it an outlier relative to other companies of its size.
A company run atypically by an unorthodox CEO is an easy target for investors who’d prefer to see the business fail. While we respect and carefully scrutinize their opinions, we’ve found there’s little weight to the arguments against Ubiquiti. Especially since they’re predominantly based on Pera’s personality and unconventional management style – this equals a bad company in the eyes of many investors.
Clearly they have their own motivations but we also respect the motivation of Pera who has an equity stake in the business now worth more than $2.8 billion. He remains focused on making his business bigger and better by continuing to innovate and introduce new products.
We understand that many people are comfortable with the status quo and shy away from controversy. As an investor we hope you understand that being unconventional can lead to greatness. By doing thorough research, we hope to avoid investments with idiosyncratic risk, where concerns are valid and the controversy is real, and instead find the handful of investments where human bias has led to the business being mispriced. In the long term, this will be a big part of how we’ll achieve superior long-term returns.
Do you believe in this thing or not?
Though we’d like to believe that all of our investors understand and believe in what we do, we know it’s not true. Human bias is a fickle friend and as much as it can lead people to believe in us when things are going well, it can lead people to doubt us when things aren’t. What we can tell you is that we believe in this thing we call Cymbria and the disciplined process we follow, and will be unwavering in maintaining our approach through good times and bad.
Many of us have been in the investment industry a long time. There came a point when we didn’t like our circumstances and rather than complain about them decided to get up and create the circumstances we wanted. Investment led, low fees, a disciplined investment approach and a commitment to open and honest communication. We’re grateful for your support through good times and bad, and will continue to put you first in all of our business decisions.
*Source: “World Federation of Exchanges 2017 Full Year Market Highlights”, World Federation of Exchanges, March 15, 2018: 3.