One of the activist investors we follow closely here at The Acquirer’s Multiple is Alexander Roepers. Earlier this year Roepers did a great interview with Forbes in which he discussed his investment strategy. He highlighted the importance of thinking like a private equity owner, and staying within your circle of competence, in order to achieve investment success saying:
“It’s a time-tested approach of investing in predictable, reliable, cash flow generators with a very much business owner mentality. We do a ton of homework and we think as if we’re going to own the whole company. It’s really employing a private equity owner mentality in evaluating publicly traded equities that are within our universe. We only want to go for transparent companies that we can analyze and understand.”
Here’s an excerpt from that article:
Since the crisis, hedge fund activists have made big headlines by challenging companies as large as General Electric, Procter & Gamble, ADP, Pepsico and Xerox to perform better, change management, or even break apart. For Alexander Roepers, a Dutch-born hedge fund activist based in New York, deploying a quieter and more focused approach drives returns at his top performing fund, Atlantic Investment Management.
Roepers is an activist investor, but instead of running public fights with company boards and management teams, he takes a softer approach, back-channeling with targets and working constructively to improve performance. Part of this playbook hinges on specialization: Instead of canvassing every corner of the stock market for ideas, Roepers invests in industrial, aviation and engineering companies where he’s emerged as a weighty and consistent investor over the span of three decades. When Atlantic builds positions in companies Roepers and his team deem are undervalued or underperforming, it generally leads to an open a dialogue. Change is accomplished without the juicy headlines of a public proxy battle.
This approach is all part of Roepers’ repeatable process. Atlantic doesn’t stray into what it doesn’t know and the $1.3 billion in assets firm has strong returns to show for it. Since inception in October 1992, Atlantic’s Cambrian fund has returned 16.1% annualized net of fees and it gained 9.7% in 2017. It’s opened this year up solidly. A newer Cambrian Global Fund has gained 12% annualized since inception in January 2012 and it gained 16.4% in 2017, according to documents obtained by Forbes.
Roepers got a taste of industrial companies in the 1980s when days after graduating Harvard Business School he joined the corporate finance department of Dover, one of the blue chips in the sector. Just on the job, Roepers was sent on the road by Dover to hunt for acquisitions. Within months, he’d bagged his first big deal, buying a California-based company called Pathway Bellows.
Through the 1980s, he worked on numerous acquisitions and the experience opened his eyes to the opportunity of disciplined investing in the sector. In 1988, Roepers decided to become an investor, specializing in what one might call “old economy” stocks. Atlantic normally invests in companies with a market value of between $1 billion and $20 billion and concentrates its portfolio to about two dozen holdings. The firm also runs a long / short strategy, where Roepers will make carefully-sized short trades. Currently, Atlantic is short Elon Musk’s Tesla. (more on that later)
In February, Forbes sat down with Roepers at Atlantic’s headquarters in 666 Fifth Avenue to learn about his strategy. Below is a lightly edited and excepted Q&A where Roepers explains his process and a few recent investments.
Antoine Gara: Can you briefly explain you investment process?
Alex Roepers: I started Atlantic in 1988 and the idea was to be only in public equities, using a highly concentrated value investing approach to a very defined universe of mid-cap, industrial and consumer companies.
It’s a time-tested approach of investing in predictable, reliable, cash flow generators with a very much business owner mentality. We do a ton of homework and we think as if we’re going to own the whole company. It’s really employing a private equity owner mentality in evaluating publicly traded equities that are within our universe. We only want to go for transparent companies that we can analyze and understand.
As a result, we avoid entire sectors, such as those with risk of technological obsolescence like biotech and high tech. In these sectors, there’s substantial risk that things can change dramatically more than anticipated through new inventions. Also, we avoid sectors that lack transparency such as banks, brokerage firms and insurance companies.
We much prefer an elevator company over a furniture maker, where the elevator company has an installed base of customers, whereas furniture maker is highly cyclical. We also don’t go with the companies where the commodity pricing drives value, for instance iron ore and coal miners, or a pure oil exploration company. We avoid those areas.
We avoid areas where idiosyncratic risk is very difficult to understand. We look for solid balance sheets, where the interest expense is less than a quarter of EBITDA and we’re looking for companies that remain profitable in all market cycles. This is important because we take a business owner mentality and also because we’re highly concentrated. In order to outperform markets over time, you need to be highly concentrated in your best ideas.
AG: You’re an activist investor, but I don’t see you on TV criticizing CEOs. How do you operate?
AR: There’s another thing that differentiates Atlantic. We’re a global research firm. We have analysts from Asia, we have analysts from Europe. We do hundreds of visits a year outside of the United States. I believe last year we did 500 company visits across the U.S., Europe and Japan.
So we have this added value to offer the companies we’re talking to. We’ve met with their competitors and peers all over the world. Once we get to the point where we know the company well, we go meet the CEO to understand why the company is undervalued. And we try to craft a road map with them, or try to understand how they could craft a roadmap that’s credible and returns them to stronger earnings or a higher valuation.
It starts with letters written to the management to be discussed at the board level. Sometimes our analysis involves operational restructuring, McKinsey-like work where we study the best-in-class peers and identify what they’ve done well in terms of working capital management, operating margins and gross profit margins. Then we plot a roadmap of blocking and tackling to get to those numbers.
Other times it involves capital allocation like buybacks and dividends. And then there’s the deployment of free cash flow; are there opportunities to enter new markets, or new products? Finally, there’s M&A. This is all self-help, things a company can do to help themselves get things right. We’re there to help them identify what they are, and to push on the things that we think are priorities.
At all times, we want to stay liquid. There’s a key differentiation. Illiquid activism, which includes board seats and proxy battles, makes very little sense to us because you can’t trade on it. We employ rigorous sell discipline on our investments, so we’re doing everything we can to stay liquid and very constructively engaged. We also want to be respectful.
AG: Give us some examples of how Atlantic’s style looks in practice.
AR: Take GKN. It’s an English conglomerate in the automotive and aerospace sectors. They build parts for drive trains and chassis and they have high market shares in their businesses. But the management believed it was too dependent on automotive so it bought Volvo Aerospace and Fokker Aerospace, in addition to a whole bunch of companies in Europe. Put together, half the business is now aerospace-related.
But they got to the point where they underperformed across the board and were vulnerable. They needed to take corporate actions to improve both businesses. They could split the company in two pieces and garner a high value, even for the underperforming aerospace business. If they didn’t do that, they’d get taken over.
We got involved in early 2016 at GBP250 and we knew the company pretty well and started to get active in speaking with management, trying to tell them how to get things on track. Things went reasonably well. It’s very important for us to be able to sell, so when the stock moved from GBP250 to GBP350, we reduced because the risk and reward was less. Then in the last quarter of 2017 (with shares floundering around GBP310), we were extremely active and rebuilt a large position. The company was about to split the business and appoint the CEO of the aerospace business as the head of the whole company. Then they realized there was a problem in his aerospace business and they fired him.
It was pretty unusual situation but it had everything. A botched succession, in addition to the actions the company could take to improve things, such as split into two. We were there proposing ideas that made sense and, frankly, if they didn’t move fast enough they were going to get taken over. Within six weeks of taking the position, they got a takeover offer from Melrose Industries (pushing shares well above GBP400) and we exited.
Right now Owens-Illinois is our largest holding. I mentioned we actively trade stocks. Today, we own nearly seven million Owens Illinois shares, but over the last eight years, we’ve bought 36 million shares and we’ve sold 30 million shares. I’ve known this company since 1984 when I came out of business school and I’ve seen it become the largest glass bottle maker in the world. Twenty-five percent of all glass bottles in the world are made by Owens Illinois, 70% of that is international. A key point, glass bottles don’t travel very well so plants are within a 300 mile radius to their market. These don’t scale and are prohibitively expensive for new entrants; so OI is a monopoly or duopoly in the 21 countries it operates in.
We’ve been trading it and been involved with it since 2009 when we bought the first in the mid-teens. It doubled and we trimmed. We’ve increased and reduced the position a number of times. Recently, it backed off to $22 a share. Right now, Owens Illinois is cheaper than almost any time ever; it’s the cheapest stock in our universe. There are a number of catalysts like corporate actions and activism that are already going on. And then there’s the prospect of a takeover. Asbestos liabilities, which have kept the private equity guys away, are now a finite issue.
AG: You also take shorts, explain why. And why are you short Tesla?
AR: The short ideas are a byproduct of what we do on the long side. As you look for great, undervalued companies you come across incredibly mismanaged companies that have done dumb acquisitions, or have grandstanding CEOs, or accounting issues and too much debt. With our shorts we take a very controlled position, normally a 1%-to-2% weight with strict stop losses.
Valeant was a controversial one to say the least because there were a lot of smart people on the long side and a lot of people were on the short side. I took an opinion initially quite early, that there was a purchase price accounting game going on with leverage, plus we looked at their drug pricing polices and decided to short the stock.
Another name that we published on, which is very controversial is Tesla. It a has tremendous following on the long side. It has a lot of detractors on the other side. We’re on the detractor side and that is rooted in my experience in the automotive industry. It is ridiculously misunderstood. The whole debate has to be removed from everything that Elon Musk is saying and everything that’s going on with electrification. The only thing that matters is the production facility in Fremont, California. That’s all you need to know. If you look at promises being made in terms of Model 3 cars sold, orders taken, Elon cannot physically, even under the best of circumstances, removing every bottleneck there is, make anywhere near the numbers of cars he’s promising. It is a money losing operation and will continue to be that way for as long as we can see.
While we’re still waiting for Atlantic’s Q2 2018 shareholder letter you can read his January 2018 Annual Letter here.
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