What Lessons Did You Learn From Max Heine? – Michael Price

Johnny HopkinsMichael Price, ResourcesLeave a Comment

Michael Price is the President and Managing Partner at MFP Investors LLC, which he started in 1991. According to Whalewisdom.com, MFP Investors has just over $1 Billion in Assets Under Management.

Price got his start when he was hired by Max Heine of the Mutual Series Fund after graduated from college.

Heine founded the Mutual Shares Fund in 1949, an open-ended mutual fund managed by his company, Heine Securities. The focus of this and other Mutual Series funds was deep-value and distressed company investing.

Price took over the fund after the death of Heine in 1988 and later sold the fund to Franklin Templeton.

A few years ago, Price did a fantastic interview for the Graham & Doddsville Newsletter where he discussed his investing strategy and what he learnt from Max Heine.

Let’s take a look…

This is an excerpt from the Graham & Doddsville Newsletter, you can read the full article here:

G&D: Activism is the new buzzword. What do you think about it?

MP: There is nothing new under the sun. We used activism at Mutual Series to represent our interests and it turned out to be a good marketing mechanism. If we would get active in a situation and the New York Times or Fortune or Forbes would write about it, it would bring money to the fund because we were doing interesting things.

People have now realized that activism is good for the money management business, but activism is not a business strategy. You should only get active when you have a position that someone else is trying to take advantage of and then you stick up for your rights. Some of these new hedge fund managers who brag about how they made some computer company sell out are not real activists.

The business is really about buying companies cheaply, and letting the management and board run it. If they do something really against your interests, you get active. But you don’t buy a position just to get active.

G&D: Has it become more difficult to cultivate information sources that are not widely held over the course of your career, with regulation FD or the advent of the internet?

MP: No. You get that sort of information from competitors, customers, former executives who have long since gone and are not privy to inside information, and other people who know the company. The internet is, however, a huge source of information about products, companies, markets and consumer preferences and all sorts of stuff. We do a lot of our original information gathering on the phone and a lot on the internet, for free.

G&D: Do you think other investors take advantage of that as well?

MP: Yes, they do. We used to have a system in mid to late 1980s called Lexus-Nexus, owned by Mead, a paper company. In the corner of my office, I would have a black box with a red top, and I used to type in a keyword on a little keyboard and they would charge me a nickel for every time the keyword hit in the search.

In a minute or two, I would have a ream of paper with some interesting sources from where I would make some calls.

Today, instead of paying a nickel, I pay nothing, and we have our computers set up to do automatic searches all the time on our positions, on our company’s products, their geographies, all sorts of stuff, for free. It is amazing what is out there, and getting better all the time.

We are involved in an arbitration related to a frozen yogurt company, where a company was taken over for a much too low valuation, and we are making the case that the company is worth much more. There is so much information on frozen yogurt consumer trends in the past five years on the internet. It could be a $3,000 trade group report and you can pull them up for free because they are six months old.

G&D: Do you find the opposite problem, that there is too much information to absorb?

MP: Yes, then it comes to your judgment as to what to do with the information. Back in 1975 and today in 2011, you still need the judgment. In 1975, you had to buy a roll of dimes to make a copy of a 10Q at the NYSE’s Library, on the fourth or fifth floor of 20 Broad Street.

I would walk over there with a roll of dimes to get the 10Q, make a copy and bring it back to the office. Now, it takes a second to pull it up on Bloomberg, just like every other SEC filing. It is the judgment after you read that 10Q that you need.

G&D: Do you think there is a lot lost in the younger generation that is so reliant to all these modern tools, like Excel?

MP: In the class I taught at Columbia Business School last week, I gave an example of the split up of ITT. I showed the class my back-of -the-envelope calculation on the valuation of the three pieces of the company on the morning of the announcement of the split. I also showed the class our Excel spreadsheets one month after the announcement, where we had refined the numbers.

Basically, the two valuations were the same. But it was the back-of-the-envelope judgment that got us started in the position, and made us work harder on the position. You have to do both. It is more than just the spreadsheet. You can get lost in the spreadsheets. You can’t rely on the projections that you put in the spreadsheets alone. You have got to step back. Spreadsheets are only one part of the whole equation of whether you want to own a stock.

G&D: What advice do you have for young analysts who find themselves stuck in the weeds?

MP: You have got to reduce the analysis to its simplest form and understand what the question in front of you is. Of course, in value investing, the question is, is it a cheap stock? You need to reduce the question to whether the stock is worth $30, and if is trading for $20 or less. You have to know how to ask the question.

First, when you are looking at a stock, reduce it to a question, and then, without the noise of Wall Street, answer the question. That means doing segment analysis, sum of the parts analysis, a judgment on the integrity of management, and a judgment on the overall economy, etc., etc.

G&D: How do you think about intrinsic value?

MP: The key question in investing is, what is it worth, and what am I paying for it? Intrinsic value is what a businessman would pay for total control of the business with full due diligence and a big bank line. The French executives at Schneider who might be bidding for Tyco, haven’t done all their due diligence yet, but they are saying the business is worth $30 billion.

We do our sum-of-the-parts at Tyco and we get there as well. The biggest indicator to me is where the fully controlled position trades, not where the market trades it or where the stock trades relative to comparables. Comparables are interesting, but they are only one data point.

Discounted free cash flows or replacement value are other such single data points. But when someone writes a check for the control of a business, like it happened with Genzyme (Sanofi is acquiring it for $20 billion), that tells you what the business is worth.

That to me is intrinsic value.

G&D: What were the some of the best pieces of advice you got from Max Heine?

MP: It wasn‟t so much advice. It was how he was with people, and how he thought about things. He didn’t like debt on balance sheets, he didn’t like good-will. He just was a clear thinker. He didn’t like the Wall Street machine. He wouldn’t play the IPO game, where everyone rushes to flip IPOs.

He would never do that. He had a great nose for value. In the 1930s, he was given $1,000 to buy furniture for their apartment as a wedding gift from an uncle. Instead of buying furniture, he went out and bought ten thousand dollars worth of bankrupt railroad bonds at tencents on the dollar, which then went up five times in value. He was a value guy from day one and trying to find cheap stocks through all the nooks and crannies of Wall Street.

Max had his own network of brokers, friends and bankers, who were in the flow of dealing in cheap stocks, like Tweedy Browne, Carr Securities, First Manhattan and other individuals, all descendants of Benjamin Graham. We had our little niche, and you took that niche and combined it with special situations, and it really worked well.

We would come up with these little stocks that nobody owned, nobody followed and we had this performance at Mutual Series that was terrific. People would write us up and look at the portfolio and say how strange and different it looked from all the other portfolios out there, filled with bankrupt Penn Central bonds, and little companies that made wheel barrels and wood products that everyone forgot about.

But those are the ones that don’t move with the market. Those are the ones that have clean balances sheets and do okay.

G&D: In terms of capital allocation for a company, what is your view for dividends versus share buybacks?

MP: I would rather own a company not paying dividends. Dividends tend to raise the stock’s price, so if I am a value buyer, I want to buy that stock as cheaply as I can. An extreme case would be a real estate trust that yields seven percent to mostly retail shareholders in this very low interest rate environment. This will make the investment trade at or above its intrinsic value. But real estate is a very illiquid asset.

I believe that real estate should be bought for a third less than the underlying value of the buildings, land, warehouses, whatever that happens to be. I would have no interest in a REIT with that dividend yield. The day that REIT comes out and cuts that dividend or omits that dividend because they have lost tenants, the stock will trade down from $20 to $13. That is when I come in because I can then get my intrinsic value.

That is precisely what we did in 2008 in the real estate space. We looked at REITs with dividend omissions. A dividend tends to keep that stock close to its intrinsic value. I don’t own Bristol Myers. Why? It pays a big dividend.

But Pfizer had both a 4% dividend and at $16, it was trading at a third less than its intrinsic value. That was a beautiful thing. A lot of managements want to pay dividends, and the tax on dividends right now is not bad, but still it is double taxation, and it does not make sense. I would tell management not to pay a dividend, and since their stock would be cheaper because of the lack of dividend, buy the stock back, and shrink the capitalization.

Dividends are very tax inefficient, because the corporate tax rates are so high, even if the individual tax rates on dividends are low.

G&D: For a young analyst, what do you recommend they do with the first four hours of looking at a stock?

MP: The really important thing is to eliminate the Wall Street consensus, the Wall Street research. Start with the quarterly or annual report of a company. Think about the business, think about what you see without any input from Wall Street, and think about how you are going to understand that company, the business values and the management. You need to understand how you are going to benchmark them.

You need to understand where the company is in the world and what the competition is for the products, whether the products are any good, and whether or not the company has any pricing power or barriers to entry. How are you going to figure these questions out, without any input from Wall Street research or any road shows?

Start calling around to people who use their products, to competitors, to trade associations. Using the press is fine. Regional or local newspapers where the company operates will often have a good sense of the management. If you are going to use a medical products company, talk to the doctors who use their products.

I never used any of the consulting sources, because I couldnt control who they were and what they did. Make your own phone calls and do primary research.

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