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all opinions expressed by Patrick and

2:00

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2:02

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2:04

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2:10

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2:15

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learn more, visit psumvc. My

2:21

guest today is Chuck Aukrey, a

2:23

now widely famous investor who founded

2:26

Aukrey Capital Management in 1989 which

2:29

now manages approximately $10 billion. We

2:31

discuss his investing style and his three-legged

2:34

stool for evaluating companies. Please enjoy this

2:36

great conversation. So

2:40

given that Chuck, this is my first time here in

2:42

Middleburg, I thought it would be a fun place to

2:44

start with the place where we're sitting. You've talked a

2:47

lot about the one traffic light town as maybe an

2:49

advantage, something very different from the typical investor. Talk

2:51

about Middleburg, why you're here and what you

2:53

love about it. We're here because of in

2:56

effect quality of life issues and I happen

2:58

to be a person who works

3:01

well without a lot of commotion around and

3:03

I know lots of people in the business

3:05

who love commotion and I've worked with some

3:07

of them. The low

3:10

level of activity around here is just helpful

3:12

for us being able to sit

3:14

there with our doors open and not be disturbed

3:16

by outside events. And

3:19

then as it relates to let's say Middleburg

3:21

versus Central Park South, if my

3:23

office were there I'd have a thousand

3:26

friends who are very bright and very

3:28

interesting and I would be distracted. I

3:31

become curious and engaged in their thought process

3:33

and it would distract me from what it

3:35

is that I do well. So investing in

3:37

an island so to speak in a very

3:40

bucolic beautiful spot. Yes indeed. We

3:42

live on a farm and that sort of stuff so it all fits

3:45

together. We're going to talk a lot about

3:47

the ideas of Nirvana investing, the three-legged stool,

3:49

the components of that, etc. But

3:51

I'd love to begin with given that you've

3:53

created this sort of interesting isolation for yourself,

3:55

what a day looks like for you. So

3:58

At this stage of your investing, Process

4:00

What Do you literally spending your time

4:02

on data days at looking through businesses

4:04

as it checking in on existing businesses

4:06

have that sort of allocated. My participation

4:08

in the businesses evolves and continues to

4:10

evolve and so on. And so I'm

4:13

personally doing less pure fundamental research today

4:15

than I did years ago. There are

4:17

others here who do that. And.

4:19

We talk about ideas and stuff all

4:21

day long. And I than a

4:23

lot am reading and that's how I. And.

4:26

So ideas bubble up in

4:28

my universe, and others here

4:31

use screens. But. Mostly were

4:33

it is am serendipitous interface and

4:35

let's just say non quantitative approach

4:37

depression Before this idea that imagination

4:39

is as are more important than

4:41

knowledge. Can you talk about that

4:43

concept a little? That was very

4:46

simple. I'm I'm in my career

4:48

run across. Literally. Thousands

4:50

of people who are very very

4:52

bright to are not necessarily good

4:54

investors and so pure knowledge is

4:56

in of itself and not a

4:58

a ticket to be a good

5:00

investor, Imagination and Curiosity or was

5:02

hugely important than we've discovered things

5:04

over the years purely by being

5:06

curious and continuing to keep involved

5:09

in the search process. to find

5:11

these exceptional businesses. To distinguish between

5:13

curiosity and imagination one sounds like

5:15

a search, another sounds like more

5:17

of a creative force was about.

5:19

Creative. My older son was a tenured

5:21

college professor for a while, and used

5:24

to say that. He worked at

5:26

a university that is. He said he didn't

5:28

have the luxury of being highly selective in

5:30

in student body and he said the thing

5:33

that disappointed him the most was than. Even.

5:35

His best students and students who got

5:37

a's. Typically. Only one and know

5:39

what they needed to know to get in a rather

5:42

than have curiosity. And I'd find

5:44

and curiosity has been useful to

5:46

me and search for investing in

5:49

and relating real life experiences to

5:51

ally meet him, pursue lines of

5:53

thought that whether it's. Trying.

5:56

To figure out why a star card track

5:58

might be interesting or. Something. They'll.

6:00

To answer is no so I guess I'm

6:02

probably not very articulate and explain the difference

6:04

between curiosity and imagination but they go hand

6:07

in hand and in being creative and ended

6:09

edifying and businesses. I think the manifestation I

6:11

love is in the nirvana three legged stool

6:13

idea of up to hear the beginnings of

6:15

that are easy talk about what those three

6:18

legs are in the stool and then I'm

6:20

always interested also in in rates of change.

6:22

Every literary have the stores here in the

6:24

room they were in which is awesome. So

6:26

we'll talk about the origins of those three

6:29

simple ideas the one on. The far left

6:31

over there is a milking stool from

6:33

Frederick County, Maryland belong to the senior

6:35

partner of my father's law firm. Views

6:37

as a million still a nice if

6:39

you can see from this angle the

6:41

one leg there in the back is

6:43

it is more of an angle on

6:46

the other two and the farmer would

6:48

who would sit down and milk an

6:50

individual cow one at a time would

6:52

take that long handle and stick it

6:54

up under his behind as he sat

6:56

down to milk gal that close to

6:58

the groundwork. Worth and. If

7:00

you observe that it's actually the three

7:02

legs are sturdier than four legs. It

7:04

can adjust to uneven ground easily. that

7:06

of four legs cannot do. I liked

7:08

to that notion and and is come

7:10

to me from my father and it

7:13

was just sitting on a table in

7:15

my office one time and I. Sort.

7:17

Of began to adopt. That is

7:19

the what I call the visual

7:21

construct for what we choose to

7:23

describe as the central component. So

7:25

what makes a great investment in?

7:27

That's something that I came to

7:29

because I. Had no background whatsoever

7:32

in the business world and I was an

7:34

English major. not been a pre med students

7:36

before I was an English major. None had

7:38

no courses in business whatsoever, so I had.

7:41

A clean canvas and a willingness and the

7:43

desire to curiosity, the learn and so. My

7:46

voyage was. What? Makes a

7:48

good investment. What makes you that investor in trying

7:50

to. Put. All this together. There

7:53

is a quantative aspect to it, but

7:55

we end up describing what makes a

7:57

good investment as each of those three

7:59

legs. I'll back up again

8:01

a little bit. say that our investment

8:03

goal has always been from the outset

8:06

to try to produce. An

8:08

outcome that's above average. but stepping back

8:10

even a step further. I

8:12

examined early and on and continued

8:15

to rates return and all different

8:17

as at categories and. Made.

8:19

The observation that the rates of return

8:21

and com and stocks. Over.

8:23

Longford time was higher than anything else

8:26

on landlords basis and distance long term

8:28

basis at the rates of returns uncommon

8:30

Sachsen, United States, and let's say roughly

8:33

the last hundred years is in the

8:35

neighborhood of nine to ten percent. And

8:37

fact, we don't care what it is,

8:40

precisely, we want to what is. Generally

8:42

we made a quantitative observation about why

8:44

that so, and that's observation is that

8:47

in our judgment, it corresponds. Correlates.

8:51

To. What the real return

8:53

on the owners capitalism those businesses

8:55

And. We. Can. Have

8:57

done many times. A quick little. So.

9:00

Until about why that so than in

9:02

conclude that are return and and as

9:04

it will approximate the are we in

9:06

our case we release free cash flow

9:09

return on the owners capital given a

9:11

constant sideways and given the abs many

9:13

distributions you get that from your point

9:15

eight back when completely in and then

9:17

you would wisely say will check. Everybody

9:20

knows you don't have caused they waste

9:22

in the market so we said we

9:24

understand that too. So we work hard

9:27

to have a modest starting. the I

9:29

was important to silly to try to

9:31

reduce that risk and so understanding that

9:33

a if our goes down Bavaria outcomes

9:35

we need to have businesses that have

9:38

above average returns. That's the first leg

9:40

we'd try to identify businesses. That

9:42

have had high returns on the owners capital

9:45

for a long time and leaves them love

9:47

them trying to figure out why that. So

9:49

what caused that and and is there what's

9:51

the runway ahead of them look like is

9:54

abroad and long. Do. They still have

9:56

the opportunity or and hybrid above these

9:58

above average return on capital. And so

10:00

on. And then we want those businesses to be

10:02

run by people who have

10:04

demonstrated they're clearly great at running the business

10:06

because they've achieved this, but also who, by

10:09

our observation, treat us as partners, even though they

10:11

don't know us. You've read it enough times, I'm

10:13

sure, but I have an expression where I say

10:15

that our experience is once a guy sticks his

10:18

hand in your pocket, he'll do it again. And

10:20

so we just have no reason to go there. I mean, it's human

10:23

behavior. We're constantly finding people whose

10:26

behavior is antithetical to our interest. And

10:28

so like one is the quality of

10:31

the business enterprise. Number two is the

10:33

quality and integrity of the people who

10:35

run the business. And then third leg

10:38

is what is their record of reinvestment and

10:40

what is their opportunity for reinvestment? And so

10:42

we have all those things that we say

10:44

once we have those in place, then we're

10:46

just not willing to pay very much for

10:48

these businesses. Those are the three legs of

10:50

the stool. People remember that, but they

10:52

get confused by this. They say, oh, yeah,

10:55

you're the three stools, aren't you, or something

10:57

like that? It was just a short-handed way

10:59

for us to sort of visually say one,

11:01

two, three, this is what's important to us.

11:03

And in our experience is that if we

11:05

own exceptional businesses, one of

11:07

the hardest things in the world is to

11:09

not sell them. All businesses have hiccups

11:12

in their business operations and all

11:14

businesses have things that occur that's

11:16

unplanned for or thought about, but

11:19

not necessarily expected. And that's life.

11:21

I mean, nothing is perfect. Nothing

11:23

is Jack Welch's 20% a

11:25

year. Take it to the

11:28

bank. Long after he's left, we found out

11:30

that much of that was a house of

11:32

cards. And so we just had our 30th

11:34

anniversary for Acre Capital Management and did some

11:36

presentations and one of our partners did one.

11:38

It was entitled The Art of Not Selling.

11:41

And it's truly very hard to do. And

11:43

in fact, it may be one of our

11:45

great assets is our ability

11:47

to not sell. I'm a quant, but I

11:49

recognize the art in each of those three

11:51

legs of the stool and I'd love to

11:53

spend a few minutes on each. So I

11:55

came across a really interesting story in preparing

11:57

for our conversation about a company called Bandad.

12:00

And I'd love to hear that as

12:02

an example of trying to identify the

12:04

essence of an underlying business's value creation

12:06

and why its ROE can be above

12:08

9 or 10 for a long period

12:10

of time. So this was

12:12

actually in the days when I was at

12:14

a firm called Johnston Lemon in Washington, DC.

12:16

And it was a brokerage firm and I

12:18

was a principal in the firm and we

12:21

had some interns around and I took

12:23

an inbox that was full of

12:26

things I'd tear out of magazines and papers and

12:28

put in the box and gave them to this

12:30

intern and said, look through there and see if

12:33

you find anything interesting. And a week later he

12:35

came back and he said, well, here's a really

12:37

interesting company called Bandag. And why is it interesting?

12:39

Well, it had very high returns on capital and

12:41

then done well for a long period of time.

12:43

And I said, well, great. What business is in

12:46

these? It's an entire business. And I looked at

12:48

the returns in the capital and said, well, it's

12:50

clearly not an entire business. What do you mean?

12:53

I said, well, take a look at the returns and

12:55

then take a look at the returns of all the

12:58

other tire businesses you find and see how they relate

13:00

to each other. And Bandag was three or four times

13:02

what they were. I mean, obviously it's not the tire

13:04

business. It's in another business. Our goal

13:06

is to figure out what business it's in. So

13:09

we went out to see them and a

13:11

fellow by the name of Marty Carver was

13:13

running the business that had been founded by

13:15

his father. He was in Muscatine, Iowa. And

13:18

I got the meeting and Marty

13:20

had his feet up on the desk and was eating an

13:22

apple during our interview. And

13:25

so you got a different feel

13:27

right off the bat. And their

13:29

business was retreading truck

13:31

and bus tires. It's something I really knew

13:33

nothing about before then. And we had been

13:36

through the oil embargo in the United States

13:38

in the early 70s, where

13:40

prices of gasoline went through the roof. And

13:43

one of the principal components of tire

13:46

molding and recapping is of course petroleum

13:48

based. And so it had caused all

13:51

of their dealers to have a

13:53

huge increase in the cost of

13:55

doing business. And when prices began to

13:57

come back down, Bandag took those

13:59

savings. And

14:01

distributed them to dealers.

14:04

On. The basis that they had to

14:06

use the money in the business. they

14:08

couldn't go buy new Cadillacs, but they

14:10

could build a new store and so

14:12

in principle competition was major dark amazing.

14:14

All of whom and company own stores.

14:17

All abandoning stores are franchised so they

14:19

were dealing with independent dealers. Who.

14:22

Says they say got their six in the morning

14:24

and closed and nine and night as opposed to

14:26

the employee dealers who got there at nine and

14:28

or named and lasted six at night. And

14:31

these people were motivated by their own profits

14:33

and whatnot. And so bang Bang. Very.

14:35

Wisely, Share

14:38

the wealth as it were with their dealers

14:40

instead of passing it all on to their.

14:43

Shareholders. That time and it

14:45

created a huge deal or loyalty

14:47

and the dealers were able to.

14:50

They. Did very sophisticated things

14:52

about identifying the. Cost.

14:55

Of fuel to a trucking

14:57

operation. If. They had a

14:59

man dang tread on their tires opposed

15:01

to some other time credits and truck

15:03

tires and bust tires are built and

15:05

designed to be retreaded to three times.

15:07

Most people don't know, that's armor. your

15:09

tires are not. Drug bust. Ours

15:11

are constructed that way. They rates. So.

15:13

They had built this huge loyalty network

15:16

of independent dealers who continued to use

15:18

the Brand Egg name and product in

15:20

their business instead of National Park families.

15:23

and as a result of that's become

15:25

the had much higher returns on capital

15:27

than other tire company and so that

15:29

was an issue of curiosity, an observation

15:32

and imagination and doing that for stuff

15:34

and making the mark of Marty Carver

15:36

and his essay his father's Out of

15:39

the Business and his Father Sir gone

15:41

off the defense. Before this he. Bought

15:44

an enormous yeah on her foot yacht. Started

15:46

on our Las Vegas show girls and

15:48

ask as a things like this as a

15:50

business. been very successful and use an interesting

15:53

experience. You have to be curious and

15:55

open to those things that have them work

15:57

out and and the day. The business

15:59

Really random. The trouble expanding in some

16:01

western European countries where they land and

16:03

do labor issues and so on. And

16:05

so we moved on. After a while

16:07

we hundred for a long time. No

16:09

one of the major trends these days

16:11

is enormous value creation by fairly young

16:13

companies That happened very quickly. The they

16:16

technology companies. In. This period you

16:18

finish to do quite well. Most excellent class

16:20

for years of Value Investor, but value investing

16:22

as a style has done very poorly. I'm

16:24

curious how your assessment of underlying business value

16:27

in that first leg of a stool has

16:29

evolved, say over the last ten to fifteen

16:31

years. Other major differences in what you're looking

16:34

for when defining it was the first differences

16:36

that in the last ten or fifteen years

16:38

the overall returns of all businesses have gone

16:40

down and then gone down in mine. Mine

16:43

in our judgments Year. Because.

16:45

The lower levels interest rates pervasive. Lower

16:47

level of interest rates. and while it

16:50

doesn't you don't necessarily a was be

16:52

blessed. See, it is a pervasive the

16:54

second. it's Gaza returns and all businesses

16:56

to be lower in our judgment. The

16:59

second thing is that the way. Some.

17:02

Of these businesses have earned their

17:04

returns. Are. Ways that we're new to

17:06

us and we didn't catch on to him.

17:08

So our returns in the last few years

17:10

which have been continue to be well above

17:12

average have been done entirely without any the

17:14

same journey. Those businesses without any of them.

17:17

And it's just because we weren't. Smart.

17:19

Enough to quick enough to certain amount. Answers:

17:21

Are you think about that moving so or

17:24

every day's learning day and we have to

17:26

figure out which of those businesses have any

17:28

of them. Are

17:30

truly attractive and are not

17:32

semi tim rapid changes in

17:34

technology or. Governmental. Intervention

17:37

or retaliatory issues relating to different countries

17:39

and different parts of the world. Answer:

17:41

As a mediator, see, wait out. Diving

17:43

deeper on that would be to talk

17:45

about recent businesses that either you've bought

17:47

a new you hold for very long

17:49

time so some of the recent ones

17:51

my be seven years old or something.

17:53

but talk about something, industries, companies. Whatever

17:55

that you find. Most. interesting results

17:57

so we try not to talk very much

18:00

about the companies in our portfolio. And we certainly never

18:02

talk about ones that are coming

18:04

in or going out. So the issues are all the same.

18:06

I mean, this is 2019 in March of 2010, we

18:11

added our first position to MasterCard and it

18:13

was during the time

18:15

of Dodd-Frank and issues

18:17

at Congress. And then more specifically about

18:19

what became known as the Durbin Amendment.

18:22

And MasterCard and Visa were selling it

18:25

10 or 11 times. And when you

18:27

dove into the numbers, we discovered that

18:29

the operating margins, returns and capital were,

18:31

there's not a word in English language

18:34

that's superlative enough to talk about them.

18:36

I would just say that you

18:39

could cut the margins at MasterCard and

18:41

Visa in half

18:43

twice and you'd still be

18:45

above average for an American business. So

18:47

clearly something extraordinary is going on there. What

18:49

does it mean? I asked this question rhetorically

18:51

around the office. What does that tell you?

18:53

Well, it tells you, A, there's a big

18:55

target on their back. Everybody wants some of

18:57

that. B tells you that

19:00

they're probably jamming every expense they can

19:02

think of into the income statement to

19:05

try to reduce how good the margin is

19:07

that they're showing. And then three, we spent

19:09

time trying to figure out what's

19:12

causing that. We think we know and we've

19:14

quit talking about it. So

19:16

I'm not gonna talk to you about it. But I mean, if

19:18

you read any research from Wall Street

19:21

and we'd read very little, there is no

19:23

one who talks about that, who talks about

19:25

rates of return that they're earning on their

19:27

capital. I mean, no one does. Because

19:31

Wall Street in general has

19:33

a completely different business model than we have.

19:35

Our business model is to compound our capital.

19:38

Wall Street's business model generically is

19:41

to create transactions. Logically, well,

19:43

what's the best way to create a transaction, to

19:46

create what we call false expectations and

19:48

what are false expectations? Well,

19:50

they're earning estimates. Oh, Shana says

19:52

you're gonna earn $1.73 next quarter. And

19:56

it comes in at $1.72 and the remark is

19:58

they missed. One So we call it

20:01

be by penny, miss, by any. That's

20:03

the syndrome. And that gives

20:05

us opportunities periodically because markets

20:07

behave in ways that we

20:10

happened to thank are irrational.

20:13

Relating. To something like that and

20:15

so a name that's been in the

20:17

news for four years now and had

20:19

some controversy around his daughter Tree where

20:22

we on a big steak. the dollar

20:24

store business was really an oligopoly

20:26

United States with three major player seminar

20:28

Daughtry Da Gen, our general had gone

20:31

to have been taken private, brought

20:33

back public by khaki. Our Star Tree

20:35

had not been headquartered in Chesapeake, Virginia.

20:37

Now on, they're basically their third Ceo

20:40

in their history and there's a

20:42

business that we. To. Experience learned

20:44

were terrific retailers and terrific

20:47

it Logistics building a managing

20:49

seven thousand stores. So

20:51

everything for Dollar Dogs nothing was

20:53

more than a dollar and two

20:56

competitors. Star General insanely darn family

20:58

dollar still run by the sounding

21:00

family basically made it said available

21:02

sale and and Dollar General and

21:04

him lots of. Private.

21:06

Conversation with him over a period of years and

21:08

then. An answer became an auction

21:10

and and Dollar Tree have a lower

21:12

bid. but once the Bin Salman are

21:14

selected them both companies Dollar Tree and

21:17

Or General simply had to bid on.

21:19

that's if it's a three company oligopoly

21:21

going to to they both had been

21:23

on. It was good because Dollar Tree

21:25

basically doubled them restores how many actors

21:27

get to that once. I'm curious if

21:30

there are other markers that you've used

21:32

heuristics over the years. in addition to

21:34

the supplied the have really high are

21:36

always or oh I see is or

21:38

something. Above the markets to.

21:41

Sort. Of be the lead generation for

21:43

see they've stood out as their yes

21:45

so what does it say or think

21:47

should be made? As simple as possible

21:50

But no simple. So lots of very

21:52

bright people to build really intriguing, complicated

21:54

ways to figure out why something is.

21:57

cheaper expensive and we try to keep things

21:59

is simply possible. And if you read the

22:01

one right behind you, sure, the bottom line

22:03

of all investing is the rate of return.

22:06

And so we use that as that's the

22:08

tool as our key tool for everything. And

22:10

we try to look at everything from a top

22:13

down basis. So we were talking about the

22:15

fangs and modern technology, we say that

22:17

as a generalization, all

22:19

of that is about changes in distribution of

22:21

all kinds, whether it's information or cars or

22:24

Amazon starting with books, and then to selling

22:26

everything in the world and then to selling

22:29

cloud services, it's all about distribution,

22:31

distribution of saving information, that

22:33

sort of stuff. And so that's looking

22:35

at things in a simple fashion. Let's

22:37

try to make it as simple as

22:39

we can understand the big context, what's

22:41

going on, because we're all at risk

22:44

of getting caught in the weeds

22:46

of what's going on. And that's misleading. Do you

22:48

think it's fair to love this idea of innovation

22:51

and models of distribution? Van Dyck was

22:53

a kind of fun and interesting example

22:55

of that. Do you tend to separate

22:58

things into product innovation and distribution innovation,

23:00

evaluating business? No, we're not that smart.

23:02

Not that smart. Seems to be working

23:04

okay now. That's important. That's

23:06

an important observation. It's working. Okay, let's talk about

23:08

the second leg of the stool, which is the

23:11

people involved in these businesses. So what are the

23:13

I love the feet on the table with even

23:15

an apple, what would you say are the most

23:17

common characteristics of managers

23:19

of the businesses that you've ended up owning

23:21

those stocks for a long period of time? Well, they

23:23

don't have a screen in their office showing them the

23:26

price of the stock. And there are lots of do

23:28

and sometimes you find it in the lobby of a

23:30

company. And sometimes you find it on the CEO's desk

23:32

that doesn't interest us. We've had

23:34

instances where principals

23:36

and companies have called us up and said, why

23:38

are you selling our stock? Once we

23:40

recover from that fronting question, if

23:44

in fact, we have been selling the stock, which

23:46

may be the case, or may have sold it all.

23:49

We say, well, actually, it was good in the

23:51

right decision, because we don't want to be partners

23:53

with people who are concerned about those things running

23:55

their business, their focus is on the wrong thing

23:57

in our judgment. And so this is an exercise,

24:00

one of the questions that we

24:02

like to ask is, I was

24:05

CEO particularly, is how do you

24:07

measure whether or not you've been a success

24:09

in running this business? And

24:12

as you might expect, some of them say,

24:14

well the price and stock goes up, or

24:17

we hit our earnings target, or we

24:19

delivered in all the things that the board asked of

24:21

us, and so on. It's a

24:24

rare occasion where the CEO

24:27

articulates an idea that shows that he understands

24:29

the idea of compounding

24:31

the economic value per share. So

24:34

you stand back and say, well why is

24:36

that so? And the answer is that

24:39

they're not trained to do that. They're trained to

24:42

run businesses. They're not trained to think about compounding

24:45

the intrinsic value per the economic

24:47

value per share. It's

24:49

really the single most important thing. That

24:51

sounds like a capital allocation story. I

24:53

know you're a huge fan of business

24:56

biographies, and some of my favorites have

24:58

always been the Henry Singleton types of

25:00

the world, who are sort of master

25:02

capital allocators, and often very flexible. Talk

25:04

about the role of capital allocation amongst

25:06

the CEOs in the second leg of

25:08

the stool. So we own a company

25:10

called O'Reilly Automotive, and

25:13

it's also part of

25:15

an oligopoly, and the oligopoly

25:17

really basically includes O'Reilly AutoZone.

25:19

And O'Reilly acquired

25:22

a company called

25:24

CSK Auto Parts, I'll

25:27

say close to 10 years ago. It

25:29

was, in fact, it was 07-08. CSK

25:31

had a huge presence on the west

25:33

coast where O'Reilly had none, presence

25:36

in the middle part of the states and southern part of

25:38

the states. Very little exposure

25:40

in the middle Atlantic and northeast,

25:42

but it gave them a much

25:44

greater national footprint. And after that,

25:46

and they did a superb job

25:48

in the logistics of integrating all

25:50

of the CSK stores into the

25:52

O'Reilly network, re-merchandising them as a

25:54

whole business. And O'Reilly's business also

25:57

was about 50% to

26:00

the do-it-for-me people, the independent garage business,

26:02

as well as the do-it-yourselfers. And that

26:04

was unusual because most of the AutoZone

26:08

and... It's competitor. Yeah,

26:10

they are a competitor. Had a much

26:12

larger exposure to the do-it-yourselfers. When

26:15

you were serving the do-it-for-me group,

26:17

the independent garages, time is

26:19

money and they had a car on

26:21

their lift. They needed the

26:23

part right away because the lift was out

26:25

of the commission if they had a car

26:27

on it waiting for a part. So the

26:30

timeliness of the delivery parts was critical and

26:32

that means that they had to have a

26:34

denser distribution network and so on. That was

26:36

pretty interesting. And you've seen the others sort

26:38

of trying to move into that direction. After

26:40

they did that, this company O'Reilly had

26:43

very little debt they'd taken on. Actually,

26:45

in 2008, because of the recession,

26:48

they were unable to borrow all the

26:50

money they'd anticipated for that

26:52

acquisition and end up having to issue

26:54

stock. And we owned 10% of

26:57

CSK at the time. And so we

26:59

got a reasonable share of O'Reilly stock, which we

27:01

still own and it's 12 or 13 times what

27:05

we paid for O'Reilly as a result of that. At

27:07

any rate, in terms of capital allocation, after

27:09

they paid off that short debt they'd used

27:11

because they were generating a lot of cash,

27:13

they said, well, we're not going to be

27:16

able to make any other major acquisition that

27:18

won't be a hardscott-rodino problem. And therefore, they

27:21

changed their capital allocation and they began to

27:23

lever up the company and buy in shares,

27:25

which they had never done. They've now, since

27:27

that period of time, bought in 40% of

27:29

their shares and are reasonably

27:31

leveraged now. It was a

27:33

really intelligent capital allocation

27:36

decision by the management and

27:38

the board at that time,

27:40

which is highly unusual. We've

27:42

all seen boards that were rushing out to buy in

27:44

their shares when they were at peak valuations and all

27:47

kinds of things. That's not what they were doing. So

27:49

that was a really interesting

27:52

capital allocation. The other side of

27:54

that goes back to the late

27:56

80s where I got involved in

27:58

a company called International.

28:00

speedway. And it's a long

28:02

story. You've probably read about it how I got involved.

28:04

But at any rate, at the

28:07

time the company had two and a

28:09

half million shares outstanding, the family that

28:11

had founded that was called the France

28:13

family. And Bill Frans Jr. led

28:15

the company was a strong and dynamic leader.

28:19

And they went through a

28:21

period of time in the 70s or 80s where they hired

28:23

a CFO where they never

28:27

had one before. Bill

28:29

Frans' wife, Ann, had always just sort of

28:32

handled the books and so on. And there's

28:34

an apocryphal story that says that once

28:36

they'd hired the CFO and they had him in the office

28:38

and they were walking him through the stuff, Ann

28:41

or Bill said, so shall we tell him

28:43

about the cash? This

28:46

is new CFO. Cash? What cash?

28:48

Well, the cash that's in the

28:50

safe. What cash

28:52

is in the safe? Well, the money we've got

28:54

for the Daytona tickets that we sold in advance

28:56

of the race. We put them in there

28:59

because we don't earn it until the races run. Float, baby. And

29:01

so interesting, then, if

29:04

you looked at the annual report, you

29:06

look down the balance sheet, there's no

29:08

debt. But when you read the

29:10

notes, they describe the equity as being 73% of

29:13

capital. What's

29:15

the rest of it? Deferred

29:18

revenue. What's deferred revenue? It was

29:20

cash in the safe. Now,

29:22

I mean, you talk about people running a

29:24

conservative balance sheet in a conservative business. That's

29:27

about as conservative as you can get. Discovering

29:29

that about the behavior of the

29:32

people, those experiences stick with

29:34

you in terms of how

29:36

people behave. I love that story. What have

29:38

been some of your favorite biographies specifically and

29:40

who are the people that they are about?

29:43

There was a man who'd been a editor

29:46

at Barron's magazine and I think

29:48

he'd written for the journal as well. He became

29:50

an investment counselor in Boston and his name was

29:52

Thomas Phelps. He wrote the book called 100 to

29:54

1 in the Market in 1972. And that was...

30:00

That was a book that to this day

30:02

remains inspirational to me,

30:04

fundamental to me in terms of thinking about

30:07

the issue of compound return. He didn't

30:09

ever explicitly talk

30:11

about compound return, but

30:13

clearly what his message was,

30:15

he outlined in round numbers

30:17

350 public companies that between 1935 and 1971, you could have

30:23

bought and made 100 times your

30:26

investment by 1972. And

30:28

so what you infer from that is that,

30:30

well, the only difference is really the rate

30:32

of return, the rate of which it was

30:35

compounding. That's the only difference. So that meant

30:37

that if you wanted to have higher rates

30:39

more quickly, you needed to have businesses

30:41

that were compounding their capital. And

30:43

so we talked earlier about MasterCard

30:46

Visa and the enormous returns.

30:48

There's no way that they

30:50

can reinvest that cash to

30:53

earn those kinds of returns and

30:55

anything else. They buy in stock

30:57

and they pay cash dividends and it grows and

30:59

that sort of stuff. But it's a less efficient

31:01

way for us to compound our capital than if

31:04

they were able to reinvest it all and get

31:06

those same kind of rates of return. So you've

31:08

got some great examples in the portfolio that you've

31:10

talked a lot about companies like American Tower, where

31:12

the reinvestment story is fascinating. And that's the third

31:14

leg of the stool. Absolutely. So

31:17

let's talk about that. You can use that or any

31:19

other example. Well, they made another acquisition last week in

31:21

Africa and bought one of the players

31:23

in the oligopoly of independent tower companies

31:25

in the African continent. And so while

31:27

each new tower is

31:29

itself a succinct individual asset,

31:32

the collection of 55,000 towers

31:35

around the world now, they all look

31:38

similar. And my

31:40

notion about the tower companies is

31:42

that they find themselves in a position

31:45

that I describe as being much

31:47

like Microsoft in the days of the

31:49

growth of personal computer. If you wanted

31:51

to have a personal computer, you ended

31:53

up having to go through Microsoft because they

31:55

own the operating system. And it was a

31:57

toll booth. And if you

31:59

want growth in wireless communication and as

32:01

we've gone from 1G to 2G to 3G to

32:04

4G to 5G

32:06

and by the way 5G is very much

32:08

of a mirage people are talking about it

32:10

and being out there on the table today

32:12

it's not going to be here for years

32:14

really and truly. Each of those demands a

32:17

denser network of towers to increase

32:19

the reliability of lack of drops

32:21

and so on and the tower

32:23

companies which are host to antennas

32:26

become that same toll booth if you want

32:28

a growth in wireless communications they

32:30

go through antennas which are mostly on towers

32:33

sometimes they're in buildings and that sort of

32:35

stuff but the tower companies are in that

32:37

business as well and so they act as

32:39

the toll booth and the growth of wireless

32:41

communication it's staggering. I'm curious though that in

32:43

an idea like that take something like retail

32:46

data centers maybe a similar take on that

32:48

like if this thing's gonna keep growing this

32:50

is sort of a toll I don't know

32:52

if you own retail data centers but how

32:54

often do you think about diversifying across that

32:56

sort of bet with a

32:59

big technology trend like the increase

33:01

in communication digital communication? Well so we're

33:03

not smart enough to dance with all

33:05

the dances we've been involved in data

33:07

centers in the past we're not in

33:09

them now I wouldn't say that that

33:11

was necessarily the correct decision but

33:13

we explore and we learn and

33:16

we observe and sometimes we for

33:18

example we think a lot about the businesses

33:20

that we've sold and was that the right

33:22

decision and we've concluded in a number

33:24

of cases that it was not but who does

33:26

it perfectly you talk about being a quant and

33:28

so on and I'm saying if

33:31

this business were susceptible

33:33

to purely quantitative approach

33:36

they wouldn't need me and you

33:39

just would punch the button and

33:42

it would solve for all your

33:44

problem that has not happened and

33:46

the really brilliant mathematician like James

33:49

Simons and is building a Renaissance capital

33:52

I don't have any idea how many inputs they

33:54

have but my guess is it's probably in

33:56

the tens of thousands of inputs which

33:59

is a step The runway and they

34:01

clearly been able to do something

34:03

that's truly exceptional and perhaps Re.

34:05

Dalyell falls in that category. Was

34:07

a little different approaches on we

34:09

don't have any that skill. We.

34:12

Don't think in those terms. We think about it

34:14

in. In. This very old fashioned

34:16

concept about business is how do you still

34:18

have a business has been successful You've seen

34:21

in talks about that where he asked the

34:23

audience and they raise their hand Is your

34:25

the price goes above Fair enough to boasts

34:28

not a public company and you have no

34:30

price discovery Honey. And

34:32

I say on the back of the am over you go

34:34

to your your account and he says well. This.

34:37

Is what the owners capitalise today and this

34:39

is what it was years on. It's hard

34:41

that by x percent and so on to

34:43

couldn't get our ideal right and so that's

34:45

why it's rate of return is what drives.

34:47

Did I understand that. Implicitly.

34:50

Thirty years ago. Or fifty years? No, no.

34:52

stuff that is right in front of your

34:54

face sometimes doesn't reveal itself in terms of

34:57

it's importance. For a long time, I. Carry.

34:59

A little point in my pocket the says

35:02

i'm a charter member, the slow learners and

35:04

deaths. In fact the case I'm not a

35:06

teenager. you mentioned this idea. we talked a

35:08

ton about price about great business is wrapped

35:11

in a bad balance sheet as American down

35:13

the Afc. Good example I was great example

35:15

and so we still own start somewhere separate

35:17

accounts and in our partnership that cost us

35:20

eighty cents or seventy nine cents. Two hundred

35:22

nine dollars a share. Today it was a

35:24

great business and in the incremental margin on

35:26

a tower. Once. It

35:28

said Let's just say to tenants it

35:31

might be one point eight or might

35:33

be two point one but two tenant

35:35

The incremental marginal businesses north. And

35:39

everything to less money in

35:41

the eighties. Was. Levered.

35:43

Candid twenty times. And American

35:46

towers leverage sixteen to fully vertically

35:48

integrated. They add steel companies that

35:50

hire actors. They are of engineer

35:52

at everything and when everything to

35:54

love me started to fall off.

35:56

The. Cliff. In March of two. That's that's

35:58

when they started far. Cliff. American Tower

36:01

had this scramble to

36:03

de-leverage itself. It had in

36:05

2002, it had come

36:09

down to $5 a share

36:11

and we owned stock. We had owned stock

36:13

when it had been spun out of American

36:15

radio in October of 1999.

36:18

And it had come out at

36:20

$15 or $16, spun out to its

36:23

shareholders and got as high

36:25

as 60. And then by March of 2002,

36:27

it was, and then by September

36:34

2002, it was two. And

36:36

on their balance sheet, they had about $6 billion

36:38

of debt, but they had, I think

36:40

it was $200 million that

36:42

was coming due in November of 2003. This was

36:46

fall of 2002. And they

36:48

couldn't use their bank lines to pay that off

36:51

because it had been money from bank line to

36:53

pay off funded debt. That wasn't possible. And

36:56

they were scrambling to sell assets to continue to raise

36:58

money. It was a relatively small amount of money, but

37:00

it was coming due. And we were in

37:02

the middle of this two-year downturn and three-year

37:04

downturn in the market that had been top to bottom

37:07

and fallen more than 50%. And we went and saw

37:10

Steve Dodge, who was the CEO, founder

37:13

and CEO in September and stock

37:15

was two and he bought more stock on the

37:17

way down at 11, that sort of stuff. And

37:19

we understood from him. He told us as well

37:21

as he told anybody who'd been to talk to

37:24

him that he could manage that problem through private

37:26

equity world. It would be expensive, but he

37:29

could manage it. And so the shareholders risk

37:31

was not a risk of the company

37:33

collapsing. It was the risk of massive dilution

37:35

because he could pay that off in cash

37:37

or in shares at their option. So

37:39

he could be taken care of, but the

37:42

risk of it to shareholders was massive dilutions.

37:44

And the stock got as low as

37:46

60 cents on October 3rd or

37:48

whatever it was of 2002.

37:52

And we bought stock at 79 cents and so

37:54

we still own some in partnership. My wife and

37:56

I still own some. And there's a great example

37:59

of Thomas Phelps. Here's a really important notion.

38:01

You only need to be

38:04

right in your investment decisions

38:07

once or twice in a career, once

38:09

or twice in a career.

38:11

And so the challenge is how do

38:13

you identify that? And so that's why

38:15

in this whole issue

38:17

of the three legged stool, the reason we have

38:19

four stools up there is they're all very different.

38:21

They come in different sizes and shapes. It's an

38:24

important notion. Visual construct.

38:26

How do you figure out which ones are

38:28

going to still be doing that 10 or

38:31

20 or 30 years down the

38:33

road? Which ones today have high returns?

38:35

And so typically you want something

38:37

that's small. So the market cap of American Tower

38:39

in October of 2002 was $200 million or something

38:41

like that today

38:43

as opposed to $100 billion today. And

38:47

I properly guessed that that 80 cent

38:49

stock, 29 cent stock was going to

38:51

be worth $209 or $10

38:54

in 11 years. No, I had

38:56

no idea. But we've continued to

38:58

buy it along the way. And

39:00

accordingly, our clients, shareholders,

39:03

partners have prospered as a result of

39:06

that. And as we say, they've

39:08

done well. So we've done well. You mentioned earlier

39:10

this idea of not selling as an asset of

39:12

the firm. This is a great example. What

39:14

are the things that would cause you to sell?

39:17

So just as we describe the

39:19

business model, the people model and the reinvestment

39:21

model, when something goes wrong

39:23

with one of those, it causes

39:25

us to re-examine. And we're

39:27

just like everybody else. We're just human and

39:29

we're fallible. And we don't always get that

39:32

right. We had a case where we sold

39:34

our holdings in Ross stores

39:37

four or five years ago. And

39:40

they had gone through a change in the CEO. The

39:43

new CEO was not made available

39:45

to the investing community. There

39:47

were some other issues going wrong at the time. And

39:50

we felt uncomfortable. We moved on and took a

39:52

profit and so on. It turns out that was

39:54

a mistake. And it was a mistake where we

39:57

didn't have it. That is, it was a

39:59

mistake. that the company has continued to do well

40:01

and we weren't part of it. They had an interesting

40:03

and a good business model. Retailers

40:06

are hard as a generalization and we've

40:08

done well in several retailers but we

40:11

conclude now and the partner here who was doing the

40:13

work on it as we'll tell

40:15

you pretty clearly he's concluded that

40:17

it was a mistake to have sold it at

40:19

the time but we didn't know that at the

40:22

time and it was a reasonable thing that we

40:24

did based on what we knew that happens. That's

40:27

the same sort of three-legged stool question but about

40:29

people that you work with. You mentioned you're in

40:31

English and pre-med major, unencumbered by bias maybe when

40:33

you came into the business. What do you look

40:36

for? An English major, a pre-med

40:38

major, a person involved in the investment

40:40

management business, they're all the same and

40:43

people, what do you mean? I said,

40:45

well, they're about collecting data points and

40:47

forming judgments around them. It's all the

40:49

same. So reading business biography, you learn

40:51

about people's behavior and

40:53

sometimes you see it through the eyes

40:55

of a biographer that maybe has a

40:57

little rose tint to the glasses and

40:59

sometimes you see it through his pure

41:02

actions and sometimes you experience it and

41:04

so I told you that

41:06

back in the 70s and 80s we

41:08

had this experience with international speedway and

41:10

we were investors in that business for over 10

41:13

years, haven't been in a long time for a

41:15

number of reasons. In the summers, I had gone

41:17

up and spent some time in Maine in the

41:19

summers and I'd gone in

41:22

the weekends and to a little dirt track, watched

41:24

the stock car racing and I noticed the dirt

41:26

track over a period of years got better and

41:28

it got paved and it got boxes

41:30

and it got better equipment and the race

41:32

cars were better. I said, well,

41:34

that's pretty interesting, you know, and I've drawn to

41:37

the idea of entertainment businesses and unconstrained possibilities and

41:39

so on. So I came back to the office

41:41

and I was a stock broker at the time

41:43

and went through the standard force corporate records and

41:45

found all the companies that were involved in horse

41:48

racing and dog racing and car racing and all

41:50

of that sort of stuff to try to see

41:52

if I could figure out if there were some

41:54

interesting businesses there and there were three companies involved

41:56

in automobile racing tracks and stock car tracks, not

41:59

Formula One or or anything like that. And

42:01

those were a company called Charlotte Motor

42:03

Speedway, International Speedway, and Atlanta Raceway. And

42:05

I invested in Atlanta and Charlotte, didn't

42:08

invest in International Speedway. It's

42:11

a long and complicated story, but Charlotte Motor Speedway, there

42:13

was a man who owned 70% of it, and

42:15

he made it private after I started buying the stock

42:18

in the market. And it

42:20

was a North Carolina based company, and I

42:23

thought that his going private price was insufficient.

42:26

And in North Carolina law, minority

42:28

shareholders had a right of dissent. I

42:31

had a lawyer in North Carolina who was a brother-in-law

42:34

of a lawyer in Alexandria, and he

42:36

ended up getting me into a class action

42:38

suit that had formed, and we went all

42:41

the way through discovery and

42:43

found that this man, who was

42:45

the chairman of the company, taken it private, had

42:47

failed to include all the corporate assets in there,

42:50

had not had independent outside appraisals, all kinds of

42:52

things, according to his pants down. He was a

42:54

thief, we had the goods on him. And so

42:56

he settled with us for, I think probably three

42:58

times something he was going private-private, and it sealed

43:01

settlement that was not to be disclosed. And

43:03

so that was the example of a guy

43:05

putting his hand in your pocket. That company

43:07

got reconstituted, it was a successful business, it

43:09

is today. There's another public company

43:12

that he was involved in, Principal Sherrlder, and a successful

43:14

public company, but I've never invested

43:17

in any of them because I knew that

43:19

man's behavior. And my experience was he'll do

43:21

it again in ways that I don't anticipate.

43:23

And we've had that happen in a private

43:25

investment where the people behave in ways which

43:27

we never expect, and we think that are

43:30

both incompetent and dishonest. And that happens periodically.

43:32

You mentioned earlier, Bill France, and him

43:34

being exceptional leader, maybe in contrast to this

43:36

guy. What was it that

43:38

made him an exceptional leader? Well, first of

43:40

all, early on, he wasn't taken with Wall

43:43

Street, and he did

43:45

things that he thought made sense for his business. And

43:48

for example, in chatting with him one time,

43:50

they had races like the Daytona 500, which

43:52

would sell out. But he knew

43:54

that his customers were, as

43:56

he would call them, blue-collar workers. And

43:59

so they were saying... sensitivity to pricing of

44:01

the tickets. And so he would raise

44:03

the price of the seats maybe once every

44:05

four or five years, and he would raise

44:07

them quite noticeably. But he had that pricing

44:09

power, and it actually related to the

44:11

old days, like the Washington Post, which kept the price

44:14

of the paper at a buck or

44:16

50 cents or something like that when everybody else

44:18

was raising prices. They had a lot in their

44:20

pricing power that they could exercise, but didn't because

44:22

they thought it made a difference. At

44:24

any rate, he would do things like that, and he

44:26

would add seats in a very modest

44:29

way so that he didn't have a lot of

44:31

unsold seats. And that changed at

44:33

the company towards the end of

44:35

his life. And then after he died, when

44:37

they got enamored with Wallstream, they started listening

44:39

to the analysts and the bankers about how

44:41

they needed to raise the prices for everything

44:43

and add way more seats. And they've gone

44:45

through all that, had the downside that experience

44:47

in the last procession, have taken seats

44:50

out and that sort of stuff. So he

44:53

was way more customer-oriented

44:55

in that business than

44:57

his successor, who happened to be his

44:59

daughter and that sort of stuff. I was

45:01

hoping to ask about how curiosity has led

45:04

you into a couple other spaces outside of

45:06

pure business and investing, your interest in land

45:08

conservation. So talk to me about the background

45:10

there, what interests you and how you're involved.

45:13

We're just great believers in the open space and

45:15

the beauty of the open space and its value

45:17

to our populations. So

45:20

the primary way that we've been

45:22

involved are putting conservation easements on

45:25

our farms and land and that's

45:28

a function of the tax code actually.

45:30

The tax code permits you to make

45:33

donations of an easement on land which

45:35

restricted future use. The

45:37

language in the tax code, federal tax code

45:39

says that these restrictions are in perpetuity. As

45:42

I say to people, I don't for a minute

45:44

believe that that will occur. Times

45:46

will change and people will figure out ways to move

45:48

around. So that means you just have

45:51

to do the best you can while you're here. But that's

45:53

true in all things. And then in addition to that, I

45:55

sit on the board of the main chapter of the

45:57

Nature Conservancy, which does land conservation. in

46:00

a very large scale and all

46:02

of the things that come from that which have

46:05

to do with in Maine as well as

46:07

other states in the United States and around

46:09

the world, restoring fish to their native

46:11

rivers and that sort of stuff by taking

46:13

out dams or putting massive

46:15

amounts of forest into hydrocarbon exchange market and

46:17

that sort of stuff, all those things of

46:20

that nature which improve the quality of life

46:22

for everybody around. I love it. In terms

46:24

of advice for young people, we talked earlier

46:26

already about imagination and curiosity and I think

46:28

those are precursors. You need to have those

46:31

things. Any other advice that you would give

46:33

younger investors or would-be investors out there in

46:35

terms of what might make them more successful

46:37

if that's what they want to do with

46:39

their career? Follow

46:42

your passion. That's the most important

46:44

thing and read like crazy and

46:47

be curious about everything. I make the

46:49

joke about the fact that back in

46:51

the Clinton administration, there was

46:53

a guy who lived at the

46:55

Jefferson Hotel who ended up

46:57

being caught by a

46:59

relationship with the dominatrix and so I

47:01

used to joke about the dominatrix's business

47:03

model. She could price however she wanted

47:05

to price and all that sort of

47:08

stuff. So it's relating real life experiences.

47:10

I say my example of pricing power

47:12

is as follows. It's

47:14

a holiday weekend, a big holiday weekend. Your

47:17

wife is having 100 people to a party

47:19

in two hours and the

47:21

toilets are stopped. You will

47:23

pay that plumber whatever he

47:25

asks as long as he can get there

47:28

before the party. That's pricing

47:30

power. So I'm always looking

47:32

for ways to understand pricing power

47:34

because pricing power is key. So

47:37

think about that as it relates to MasterCard and

47:39

Visa and all of these things. What's the source

47:41

of their pricing power? They say we have our

47:43

notions and we don't talk about it anymore and

47:45

you'll notice that the company never talks about it.

47:48

Yeah, I love it. My closing question for everybody

47:50

is for the kindest thing that anyone's ever done

47:52

for you. Wow. Well,

47:54

that's probably personal. So I won't share that. But

47:57

the willingness of. of

48:00

people to make

48:02

themselves available, whether it's me or

48:04

somebody acting towards me or my

48:07

family is incalculable in terms of its

48:09

value to use a human being. So I spend a

48:12

fair amount of my week every week trying to figure

48:14

out what I can do to be useful to other

48:16

people. Well, this hour has been a good example

48:18

of that. So I appreciate it. It's been an hour. Holy Moses. Appreciate

48:21

your time. Thank you very much. If

48:24

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