In this episode of The Acquirer’s Podcast Tobias chats with Joseph Calandro, Jr. During the interview Joseph, who is the author of Applied Value Investing and 50 research publications, provides some great insights into:
– Investors Can Find Value In Companies With ‘Hidden Assets’ – Case Study Disney Buys Marvel For $4 Billion
– What Are The Steps Investors Can Take To Uncover A Company’s Hidden Assets
– What Is Information Advantage
– Why Is It So Difficult For Companies To Adopt A Value Investing Strategy
– Why Was Buffett So Wrong On Gen Re And So Right On Geico
– His New Book Due Out Spring 2020
The Acquirers Podcast
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Tobias Carlisle: You ready?
Joseph Calandro: Ready.
Tobias Carlisle: Let’s do it.
Tobias Carlisle: Hi, I’m Tobias Carlisle, this is the Acquirers podcast. My special guest today is Joseph Calandro, Jr. He wrote a spectacular book in 2009 called ‘Applied Value Investing’, which is about applying value investing principles in a corporate context. And he’s written, in addition to that, 50 research publications. He’s got a brand new paper that’s fascinating and timely because it’s about Marvel, which is about to release the biggest movie of all time, April 26, which is when this podcast comes out. Joseph’s been looking at how Marvel did it, where it came from, because it was in bankruptcy in 1996; so we’re going to talk to him right after this.
Speaker 3: Tobias Carlo is the founder and principal of Acquirers Funds. For regulatory reasons, we will not discuss any of Acquirers funds on this podcast. All opinions expressed by podcast participants are solely their own, and do not reflect the opinions of Acquirers Funds or affiliates. For more information, visit acquirersfunds.com.
Tobias Carlisle: Hi Joseph, how are you?
Joseph Calandro: I’m fine. How about yourself, Toby?
Tobias Carlisle: I’m doing very well, thank you. You’ve written a brand new paper, it’s called ‘M&A Deal Making. Disney, Marvel, And The Value Of Hidden Assets’. What is a hidden asset?
Joseph Calandro: So it is what the title says, it’s something that’s on the balance sheet that’s frequently ignored. So Seth Klarman wrote about this in his classic ‘Margin of Safety’, and he gave three examples.
Joseph Calandro: So the first was overvalued pension funds. Now you can kind of tell how old that book is just by that, because many pension funds aren’t overvalued anymore; but at the time of the writing, pension funds were overvalued. Same thing with real estate kind of carried on the balance sheet at prices far less than the market value, and the third one is profitable finance subsidiary.
Joseph Calandro: Now each one of those is, as all your viewers know, are kind of well known now, they’re no longer hidden. Balance sheets are transitory, but just because these historical examples really are no longer “hidden” on the balance sheet, doesn’t mean other things aren’t.
Joseph Calandro: And more and more what we’re seeing on the corporate finance side is that hidden assets can be involved in a tangible asset, so it’s very hard to get your arms around an intangible asset, as you know. But to the extent you can do that, there could be a significant profit opportunity as there certainly was with Disney when they acquired Marvel.
Tobias Carlisle: So let’s go back a little bit further than that. In 1996, Marvel filed for bankruptcy, which people might-
Joseph Calandro: It did.
Tobias Carlisle: Find shocking now, because the movies are everywhere-
Joseph Calandro: Right.
Tobias Carlisle: And regular. And there was a battle for control between two very well known corporate raiders: Ron Perelman and Carl Icahn. They didn’t actually end up with control or they both lost; so tell us who won and what he paid.
Joseph Calandro: Yeah, so that’s a great question. Just by way of background, when I was actively teaching, I teach by the case method and, by far, the most popular case I ever taught was the Marvel bankruptcy case. Again, you have Ron Perelman and Carl Icahn duking it out; it really doesn’t get much better than that.
Joseph Calandro: But for the topic that neither one of them won, someone else, a man by the name of Ike Perlman came in and actually acquired it. And going through exactly how Marvel got into trouble focusing on the battle of control but, more importantly, who won and why. So, at the time, Ike Perlman had a minority interest in Marvel, because he was the owner of a firm called ‘Toy Biz’, they make the toys for the comic book characters.
Joseph Calandro: So, why that’s important is who his number two was, it’s a man by the name of Avi Arad who, as your viewers may know the ones who will follow the movies, he was behind the kind of first generation of Marvel movies, Things like X-Men, the first run of Spider Man and the like. And, he made quite a bit of money for Marvel by doing that.
Joseph Calandro: So successful were they, that if you fast forward to 2009, Ike Perlman’s $238 million investment in Marvel, at that time, grew to $4 billion and Disney decided to acquire them. And we can, certainly, talk about that.
Tobias Carlisle: Well, I was just going to say that’s a … Bob Iger, I think, was the CEO of Disney at the time.
Joseph Calandro: That’s right.
Tobias Carlisle: And he took a fair bit of heat for that price, because there was a suggestion that it was way too high for those assets, but I think-
Joseph Calandro: That’s right.
Tobias Carlisle: You describe in your paper as 57 percent above what the future value, the net asset value, you described as an expected growth requiring a 20 percent reinvestment rate. So can you just … How are future value and so on arrived at, and what was the plan for the expected growth?
Joseph Calandro: Yeah, no great questions. So, again, a little bit more context before I get right into the answer. I published a paper in a strategy journal, Corporate Strategy Journal, on the Marvel bankruptcy and then, literally, six months or so later Disney acquired Marvel.
Joseph Calandro: So it’s better to be lucky than smart, the editor called me and said, “Hey, can you take a look at this?” And I don’t like commenting, especially in a research journal on recent transactions, but this one was really kind of too good to pass up. And you’re right about Bob Iger, and the quote that I took in a quote in the paper is, his statement at the time was, “We paid a price that reflects the value Marvel created and the value we can create at one company. It’s a full price but a fair price.”
Joseph Calandro: So as a value oriented investor and analyst, if you paid a full price, how are you going to make money? So that was really the quote that got me interested in it and then I looked at it and I applied the value approach on top of it. And sure enough, it came to when you take it through net asset value, earnings power value, franchise value, growth value, over half of the value is locked into growth. And when you look at the reinvestment rate, it’s over 20 percent; that’s a very hard hurdle to overcome.
Joseph Calandro: So, I very rationally commented that it does not appear that there is no margin of safety in this price, it’s going to be very tough for Marvel to … excuse me, for Disney to profit from this acquisition. I was clearly very, very wrong and understanding why and how I went wrong is the topic of the current paper, which is my third on Marvel.
Tobias Carlisle: So how’d they go wrong? How did Disney go right, rather, how did they exploit those first hidden assets to, that they’ve made many times over that expected growth value that they paid?
Joseph Calandro: Yeah, it’s a great question. And the thing that struck me was when I went back, it’s like most people, I don’t like to be wrong. But unlike most people, I try to really figure out where I went wrong, why, and to learn from it. And the part about this that shocked me was is that Iger did not lie. He was, his statement he was absolutely right, he did pay a full price for Disney and a fair price, based upon the general consensus at the time; and that’s important.
Joseph Calandro: So let’s kind of go back in time, Iron Man came out, it did very, very well. It was immediately followed by the Incredible Hulk, which did not do that well; it made some money, but not a great deal of money. And even though Robert Downey had a cameo appearance at the end, the famous star of Iron Man, and now he’s one of the three key faces of the Marvel Cinematic Universe.
Joseph Calandro: It was at that point where, if you’re just focusing on the intangible assets of Marvel on a picture by picture basis, it will lead you to that $4 billion price, plus or minus depending upon how aggressive you are; but that’s where you’re going to end up. What that valuation does not consider, at all, is the value of integrated story arcs, and character team ups which is what Marvel, under the amazing leadership of Kevin Feige who, in my opinion, he is to the Marvel Cinematic Universe with the late Stan Lee was to Marvel.
Joseph Calandro: He put together an integrated story arc that was planned out 10 plus years into the future, and then he really focused on executing on each movie, and he wanted to make each a success, not only as a standalone property, but as part of a broader universe that culminates in these key team-up movies such as the Avengers which, I think, came out in 2012. We just had Thor: Ragnarok, that was another one, Captain America: Civil War was another one and now with the Avengers movie, End Game, being released at the end of this month.
Tobias Carlisle: So you describe the strategy to exploit these hidden assets or, in particular, these intellectual property character-type assets as a ‘blue ocean’. And you said that there are some risks that the blue ocean may end up being a mere puddle, so how do you navigate those risks?
Joseph Calandro: Yeah, so I’m …. By way of background, I’m in a corporate strategy practice, and I’m not a strategist by training, I came in on the kind of the finance side as well as the industry side, the economic side. The blue ocean concept is a very, very popular strategic theory which says, “Don’t try to do what everyone else is doing, look for basically white space, the blue oceans, and try to capitalize on those”
Joseph Calandro: Now one of the problems with corporate strategy can be when you find something that looks like a seeming blue ocean, as you really get into it, it could turn out to be a puddle, rather than a blue ocean. So this is the reason why, as you know, given your background, so many corporate M&A deals don’t deliver on the value expected because the blue ocean that they saw with synergies and variety of other things, really didn’t come to materialize.
Joseph Calandro: The same thing can happen with anything intangible, such as hidden assets like this. So, there’s a number of steps we identified to go through if you’re going to focus on this that will lead you to believe that, first of all the hidden asset is really hidden and that’s really real; it is a real asset even though people aren’t currently paying attention to it.
Tobias Carlisle: Can you take us through those steps and how corporate value investors or how corporate teams can apply those to acquisitions?
Joseph Calandro: Yeah so great comment. And with respect to corporate value investing teams, they’re certainly there, so firms like Lowes, of course, Berkshire Hathaway, obviously, Markel, Fairfax, so there are a few, but they are very, very much in the minority.
Joseph Calandro: Being a value investor meets, inherently, being taking a contrarian approach, most people can’t do that. For a variety of reasons, they kind of follow conventional wisdom, and they stay on the beaten path, they won’t go outside of it. So when I’m talking to an executive, I never lead off with the value side, or I’ll bring topics in depending upon the business problem I’m there to advise on. So with respect to M&A, and especially if it pertains to a potential hidden intangible asset is number one, are the assets really unseen?
Joseph Calandro: So, if you look at Marvel, everyone was focusing on the movie by movie performance of the studio; no one was really focusing on the value of the integrated story arcs, even though they were clearly there. And if you look back in the comic book history, you saw it, the Avengers was a moneymaker for Marvel for quite some time. And that’s the second principle that the assets are really assets; they have some type of earning power.
Joseph Calandro: Integrated story arcs clearly had that, they were there at Marvel for quite a long time, but no one was paying attention to them with respect to the studio; so that’s kind of the second one. But that only gets you so far, the core to all of this is a focused value realization strategy. So, how are you going to do this, how are you going to realize value from it? Or in the case of Marvel, create value from it?
Joseph Calandro: Because, again, at the steady state, the value that they could earn basically earned the price that they paid; it’s a wash. Clearly their stockholders wouldn’t have approved the deal if it was just a wash, so how are they going to earn more than that? And, I think, that is the reason why Kevin Feige undertook the approach that he did was to plan these movies out over a decade or more, so you could see, not just on a movie by movie basis what was going on, but how they fit into the cohesive framework and kind of what it would mean. And then once they had that, then it came down to the operational expertise.
Tobias Carlisle: So just so I can understand, what Marvel had been doing was releasing the movies on a single movie by movie basis.
Joseph Calandro: Right.
Tobias Carlisle: Find a character, and then release that movie. And Kevin Feige … is that the gentleman’s name?
Joseph Calandro: He’s now the President of Marvel Studios.
Tobias Carlisle: His insight was that there was these Avengers, which were collaborations where several characters were brought together, and then they can have a very long story that went from their collaborations and into their individual movies and back again. And he saw that he could use that, which that sort of format had been used previously, and that would create more interest in the franchise and generate more money through ticket sales and so on?
Joseph Calandro: Well, that’s right. And it’s not just through a formal group like the Avengers. So the third movie in the Captain America series was a very famous one where Captain America and Iron Man fight. The same thing Thor, the third Thor movie involved not just Thor, but Thor and Hulk.
Joseph Calandro: So you’re getting interaction with two key characters, two or more key characters, and then you have the kind of broad group of the formal Avengers kind of doing it; and it was a way to kind of monetize these characters. So for example, if you look at the Marvels chief rival, DC Comics, they also have a movie arm; they have been far less successful in doing this. They had mixed success handling their properties on a movie by movie basis, but far less integrating it, so it’s not very easy to do, and there are a number of steps that are required to kind of do it.
Joseph Calandro: But to the extent people like these characters, why wait two to three years between movies if you could release a solo movie, then a team based movie and then the broader version of the movie? People are seeing these characters almost every year, and that’s not going to generate just movie revenue, but there is kind of a comic book underlay to all that that’s going to profit. There’s, obviously, toys there’s apparel, there’s also cartoons. So the money making machine, once it starts to roll this way, can be mighty and Disney certainly showed that here.
Tobias Carlisle: To identify that hidden asset, particularly in relation to the comic books, requires some deep familiarity with the subject matter. And I just compare that to that sort of old school value investing approach, I mean, I’ve done this before. You run a screen for real estate-
Joseph Calandro: Yeah.
Tobias Carlisle: That was purchased back in the 70s or 80s that’s been sitting on the books for a very long time, and it’s carried at book value and, presumably, there’s been some appreciation that may not be reflected in the asset value or may not be reflected in the earning. So is that one of the things that you have identified that is really is somebody who has this deep familiarity with the subject matter, and to have that unique insight that allows them to pay more and then make it work?
Joseph Calandro: Yeah, so that’s a great question. And it’s on the consulting side, we formally call it ‘information advantage’, and that’s something that professional value investors also do;having that deep familiarity with the subject matter. And, again, because more and more people are becoming sophisticated with financial statements and tools, it’s very difficult, especially if you’re not one of the really major value investing firms, to get a leg up on these people.
Joseph Calandro: So Mario Gabelli’s firm, Seth Klarman’s, Mitch Julis, Howard Marks, the late Marty Whitman’s firm. I mean, these are all extremely successful value investors with deep staffs that study and look at these things 20 hours a day. It’s very difficult for corporations to compete with them or anyone else, except in areas where the information advantage is flipped.
Joseph Calandro: And if you weren’t in media and a party … One of the reviewers to this paper said, “No one but Disney could have done this.” And I don’t really believe that, I mean, looking back it’s very easy, the narrative fallacy, to make all sorts of excuses why Disney was … They took a lot of heat doing what they did and it really wasn’t a layup for them, they took chances, they were very studious, and they were really methodical about how they went about doing it.
Joseph Calandro: And I had another reviewer say, “Well all the Marvel properties.” I mean, there’s really nothing strategic to this. They’re just good characters and every movie associated with them makes money, and that’s certainly not true. I mean the Fantastic Four movie that came out a number of years ago did not do well, and actually lost money for 20th Century Fox; because they did it the wrong way. If you don’t do it the right way, you’re not going to make the type of money that certainly Marvel made and, again, value investors in general, aren’t known for acumen in the intangible space.
Joseph Calandro: So there was a strategy book written by a very prominent professor on the value side, or he very famously said that, “Apple was going nowhere.” And this is before the great Apple boom; clearly wrong. I was clearly wrong when it came to Marvel, and even Warren Buffett when he bought General Re. I mean, there were problems there, he paid more than he probably should have.
Joseph Calandro: So there are blind spots there, and kind of one man’s blind spot is another person’s strength. And if, to the extent corporate strategists can kind of take this approach and view it from the lens of their industry and their firms, they could potentially have an information advantage over the bevy of value investors who are trying to do the same. And then if they do that, kind of create value in a way that could potentially transform their industry the way Marvel certainly has with the extended cinematic universe.
Tobias Carlisle: I think it’s interesting that that reviewer said that Disney was the only one who could make it work, because the thought did occur to me that Disney was probably uniquely positioned because they have that familiarity with-
Joseph Calandro: Yeah.
Tobias Carlisle: Characters, and how to use characters, and they have distribution and other advantages. Do you see what they’re doing … Their success with Marvel, do you think that that led them, perhaps, to the acquisition of Star Wars with the same sort of view, the same approach?
Joseph Calandro: Yeah, so, that’s another good question. So let’s look at it this way, before they bought Marvel for $4 billion, they paid almost $8 billion for Pixar. And, again, Pixar with the Toy Story movies properties has done very well, nowhere’s near as well as kind of Marvel has done.
Joseph Calandro: They did purchase Star Wars, the Star Wars movies have had some problems associated with them. I don’t even watch them anymore, I just find them just completely uninteresting, and a number of friends of mine I felt the same way; both younger as well as older. So, it just goes to show you, it’s not really a layup, and I think why it hasn’t been a layup for them when it comes to Star Wars, why Star Wars movies seem to be so bumpy is the people. It’s kind of the operational people, processes, and technologies that bring these things.
Joseph Calandro: So again, we mentioned Kevin Feige on the Marvel side, it’s not just him, he has a team under him, but it’s his team, and they have proven themselves exceptionally capable with this. And I don’t think you’re seeing the same type of talent on the Star Wars side. Now that doesn’t mean Disney is going to lose money there, because I don’t think they are, I just don’t think they’re not going to be able to maximize it in the same way as kind of Marvel has; it’s not easy to do.
Tobias Carlisle: And this is a data point from your paper that Marvel, sorry Disney, since the acquisition of Marvel has produced something in the order of 20 movies, and they’ve generated $17 billion in revenue and that’s excluding the Avengers end game which comes out today, which I think that the presales… There’re more than a billion dollars in pre sales, which is extraordinary.
Joseph Calandro: Yeah, I talked to one analyst and he thinks that, again, we’re just talking about movie revenue, again we’re not talking about comic book revenue, toy revenue, apparel and animated cartoons on television; this is just movies. The analyst I talked to says, “There are some people that think that this latest movie endgame could make $4 billion in and of itself, which is twice what the last movie made.” I mean, again, it does not get much better than this from a … If you’re a shareholder at Disney you’re very happy with kind of what they’re doing.
Joseph Calandro: Again, it’s not to downplay how difficult it was to do this, but for established characters like this in media, or for other kind of established intangible assets, it certainly is possible with you paying the right price, because I think the way Disney looked at it was, look at best at worse case. Our worst case is a wash, that’s not a bad worst case if we have other things kind of going on where we can certainly make are required rate of return, but the optionality is so convex, that if this does work, I mean it’s going to be what it is today.
Joseph Calandro: And if they’re creating a portfolio of these things across their vast empire, you’re going to have certain things that work certain things that don’t work, but if they can kind of institutionalize what Marvel did into some of the more underperforming or lesser performing brands; as we’ve seen, the appetite for this type of thing with the consuming public is inexhaustible. Their potential for profit is equally inexhaustible to the extent they can deliver.
Tobias Carlisle: Disney’s stock has done reasonably well, but it’s been sideways for the last recent, it’s one of those stocks that I hear lots and lots of Buffett stuff, franchise investors get quite excited about. Do you have any view on Disney stock, itself; are you allowed to comment on something like that?
Joseph Calandro: So I can’t comment on the buy and sell side, because I am an advisor and I believe they are a client of the firm that I work for. But what I can say is what you would already know, now people expect this from them, and that expectation is going to kind of flow through the price. So the question for them is going to be, “Okay, kind of what’s next?”
Joseph Calandro: They just took over the properties from 20th Century Fox. Again, 20th Century Fox has had some wins, they’ve had some misses too, and they haven’t been able to kind of integrate their universe. So there is the potential there to fold those properties into the Marvel kind of universe and really extend the current strategy.
Joseph Calandro: There’s a variety of things they can, no doubt, do on the Star Wars side as well. Where Star Wars gets a little iffy is they don’t have the decades and decades of source material that the Marvel characters do. They’re certainly trying to kind of fill that need but, again, it’s been kind of lumpy. And then, of course, there’s cruises and a variety of other things kind of associated with it.
Joseph Calandro: However, they have a habit of reinventing themselves, they are very good at that. This is the firm that really kind of made its bones with Snow White and the Seven Dwarfs 70 plus years ago; I would not bet against them. Whether it’s going to happen next year, or five years, or 10 years from now; I have no idea, but they have shown themselves consistently capable of producing mega-sized initiatives and returns like this. And look, I’m on the risk side so I’m a betting man, probably like you are as well; I would certainly not bet against them.
Tobias Carlisle: Your practice area and your area of interest in research has been the application of value investment principles in a corporate context. What’s the difference when managers in a company try to apply these principles versus someone in a firm who probably has a freer hand with where they can go?
Joseph Calandro: Yeah, so the … it’s interesting because I’m asked this a lot when I guess speak at colleges or universities. And I begin my response by saying there is a reason why all of the value investors we know have started their own firms. And so Warren Buffett started Berkshire Hathaway, Mario Gabelli started GAMCO, and you can go down the list, I mean, they in some form or fashion were involved in starting a firm.
Joseph Calandro: Because it’s very, very difficult to take a contrary view in a firm that’s not organized that way. So as you know, given your background, organizational momentum has a certain logic to it. So there’s a way of doing business in firms, there’s a way of doing business in industries. Each function that’s involved in a firm has a certain way of doing what it is that they do going about their work.
Joseph Calandro: And at many times, it involves doing what pretty much everybody else is doing, buying what pretty much everyone else is buying, and paying what everybody else is paying; it’s far easier to do that. If you want to go off the beaten path and take a completely contrarian view, and you don’t have a company wired that way, at best you’re going to get shot down; at worst, you’re going to have to find another job.
Joseph Calandro: I had a Chief Innovation Officer describe it this way, “Firms are created to suppress innovation. The innovation was involved in creating them and then delivering on it, and then it ends.” He goes, “That’s just what happens and you’ve got to find a way to work it into the organization.” If you can’t do that, again, at best you’re going to just basically go flat and your career; at worse, you’re gonna have to find another job, so it is very, very difficult
Joseph Calandro: Increasingly, firms are … I mean, it’s much easier for me today than it was seven years ago when I started consulting firms. For the simple reason that many clients have a variety of problems that have gone through the business as usual process, and there’re still problems. And at that point, it’s like, “Okay, well let’s look at this differently.” My hit rate on those types of things are very, very high, and successful delivery is exceptionally high and remains so to this day.
Joseph Calandro: But if it pertains to an area that’s kind of well covered, it’s far less so; it’s mixed. Sometimes they’ll take the input, other times kind of they will not. So it is very, very difficult if you haven’t started your own firm for just work for an exceptionally entrepreneurial open minded executive. And, again, if they’re there, they’re clearly the outlier, they’re not the rule; they can’t be, average means average.
Joseph Calandro: And in many social distribution probability functions, there are fact tails. When it comes to management expertise, it really isn’t normal distribution, I mean there are a variety of managers who are average, and there’s a very select few like Warren Buffett who outperform. And there’s a very select few grossly underperform like the Enron folks did or, the too big to fail banks that did go into the crisis; fortunately.
Tobias Carlisle: I imagined that it’s very difficult to be a manager and consider acquisitions when … This is an observation that I have when I’m … Companies and industries tend to get expensive and cheap at the same time, because they’re all subject-
Joseph Calandro: Right.
Tobias Carlisle: To that same business cycle in their industry. So when you’re flush with cash, so are your competitors.-
Joseph Calandro: Right.
Tobias Carlisle: So when you try to add something in your own industry, you’re trying to buy a company that’s going very well, and you’re competing with other potential bidders who are also doing very well. If your thought is, “I’ll go outside the industry to buy something adjacent to what we’re doing.” Then the challenge that you face is you have to persuade everybody on the board that’s a good idea, and they say, “We’re doing well in this industry, why would we look at a struggling industry next door?”
Joseph Calandro: Well, that’s right. I mean, it does happen. I mean, what led me to write the first paper on Marvel was it had been a few firms that undertake distressed M&A when their industries are going through distress; not a lot, but there are some. With respect to adjacencies, I mean, you look at a value investing based manager like the late Henry Singleton of Teledyne, Warren Buffett said that he had the best capital allocation record; I think that record still stands today. Although Kevin Feige and Bob Iger are kind of challenging it with what’s going on at Marvel.
Joseph Calandro: But, I mean, he had a traditional conglomerate, but the parts worked and he made it work. And I spoke to people who have worked for him, and he was just an exceptionally talented man and skilled man; not just in his core technological competency, but finance, strategy, and in a variety of other things. If you have the right executive, and the right team, with the right vision, it can be made to work.
Joseph Calandro: The problems, I think, start when … It’s necessary for running a business, as you know, to manage function by function. I mean, the accounting books have to come out, current products have to be sold, they have to be serviced; there’s no way of getting around that. Some firms right now are trying to get around it by creating special innovation functions.
Joseph Calandro: My firm advises on that, I’m not a big proponent of a separate innovation function. If you’re going to be innovative, be innovative just recognize it for what it is. I mean, there’s a time and place for business as usual, there’s a time and place where you’re going to try to do something new, and there’s kind of ways and processes to approach each; and there’s no reason why that can’t be done within the constraints and confines of one enterprise.
Tobias Carlisle: Are you ever part of the discussion at a board level whether a company should buy back stock, or pay a special dividend, or any of those sort of considerations than as opposed to doing an acquisition?
Joseph Calandro: So I’ve advised executives on it; not that topic at the board level, for a variety of reasons. And when I, again, when we talk to finance executives, it puts them in a tough spot. And so a CEO at a board wants to do a buyback, and the stock is fairly priced on the marketplace, but your boss and his boss, meaning the board, want to do it, it’s kind of hard to go in there and argue we’re fairly priced; very few of them do. I mean at that point, the decision’s been made, it just becomes a matter of you’re putting the transaction through.
Joseph Calandro: And again, that’s part of the organizational dynamics I talked about. Whether that’s right or wrong is a subjective question. As a value guy, I wouldn’t want to do it, but again, as an employee, I understand why they want to do it, we had nothing else to do with the cash, you have to put it to work; I mean there’s a whole host of ways of rationalizing it.
Joseph Calandro: Again, it’s very difficult to take a position like Mr. Buffett and other value investing CEOs have to say, “Well, I want a lot of cash on the balance sheet, I really don’t care what kind of current returns are. Given where we are the cycle what’s going on, I need cash because when this corrects, opportunities are going to come up, my phone’s gonna ring, and I want to not just answer it, I want to answer it with, “Okay, I hear what’s going on, I offer you X. Ready cash, payable right now”.”
Joseph Calandro: When companies are in distress, it’s very hard to say no to that. But it’s also very hard to kind of explain that to a board, and to other types of organizational committees and structures, when they’re not philosophically wired to kind of think that way, and when they’re focused really on the here and now, for whatever reason, rather than the next five or 10 years.
Tobias Carlisle: Joe you’re a managing director at a very large global consulting firm, you’re a fellow at the Gabelli Center for Global Security Analysis, and you’ve written all this research publications, how did you get started, and how did you find this as your area of interest and what did you study at UNE, and how did you get to this point?
Joseph Calandro: And so in a very long circuitous way, so came out of college started work in the insurance industry and liked it; that’s why I stayed in it. And then in 1992, Hurricane Andrew struck and then that was a seismic event, and I knew that things were going to change. So I dug out the old calculus books, and I boned up on my derivatives pricing, and I was kind of fascinated by it so I started trading. And, statistically, it wasn’t through fundamentals and for my first four years, I did exceptionally well, so ridiculously high chart ratios. I mean, I thought I kind of had it all nailed.
Joseph Calandro: And then we go into 1997, I’m up almost 50 percent, heavily net short the dollar and then currency markets close at 3 p.m. and at 3:02, the global central banks come in and defend the dollar. My stops were clearly run, I couldn’t get out, and I went from being up massively to being down. I think I stayed up two days kind of fighting the position, and I liquidated.
Joseph Calandro: And I told the clients that I was working with … I sent them back their money. And a couple called me back and said, “Why are you doing this?” And I said, “Well, look no one likes losing money, but I don’t understand how I lost money or why.”
Joseph Calandro: So for the next three or four years, I kind of investigated the how or why, and if you read the book ‘Fooled By Randomness’ by Nassim Taleb, I made all the mistakes he outlined in that book; absolutely everyone and I learn the lessons the hard way.
Joseph Calandro: And I was working for General Re at the time, and then Warren Buffett bought it and he paid $22 billion for that firm even though they had a book value of $8 billion. I knew, by working there, that it was not a franchise, probably was in trouble, but I can’t get over what he saw that I clearly didn’t see. And then a quarter after he bought it, January’s results tanked and it’s trouble for him quite a long time.
Joseph Calandro: Here’s the most successful investor in history, he made a huge mistake like how did this happen? So I took a value course at Columbia, I really kind of got into it, and the immediate logic of it really kind of hit me. Rather than assume all these things away in a model, like I did when I was trading, you really deal with them up front through a process. You kind of make an initial assessment, and then you dig into things to find out, “Okay, does that initial assessment need to be adjusted upwards or downward and why?”
Joseph Calandro: And the value investors who do this, professionally, are very, very good at that, really kind of understanding, line by line where the value is, where it’s not, if they can profit, how and then have a process in place to kind of surface that value over time; exceptionally good at it. But when I finally figured out that that’s what they were doing and how they were doing, I’m in my late 30s which is, I did not want to go back and try to manage money again.
Joseph Calandro: I have a family to support, like most people, and I like the business world. I mean, I like corporate America, so how to kind of bring this in and I really focused on the kind of risk side and the M&A side, and I can certainly give you examples on how I integrated this into both my practice, as a consultant, and on the corporate side if you’d like.
Tobias Carlisle: Well, sure why don’t we start with what was Buffett’s mistake with General Re? My recollection is they had these enormous derivatives positions possibly Buffett and Munger hadn’t fully appreciated how extensive they were.
Joseph Calandro: So there was derivatives, and they were there, they really weren’t problematic; that wasn’t really where General Re went off the rails. Where they went off the rails was their kind of core business, the business of insurance and reinsurance underwriting. So you got to understand where we were in ’98 and ’99, from an industry perspective. The insurance / reinsurance market, at that time, was what we call ‘very, very soft’. I mean, prices were very depressed and terms and conditions were very, very broad.
Joseph Calandro: It was a particularly vicious soft market cycle, not unlike what we think may happen on the insurance and reinsurance side over the next five or 10 years. So, GenRe, pretty much every other player, or most of the other players in the space, really let their underwriting controls slip, they let their reserve slip, and it’s a long tail business, meaning that you sell a policy today and the claims don’t really start till five, six, seven years in the future; however long, but it’s not instantaneous.
Joseph Calandro: So, the problem with insurance is you really don’t know what your cost of goods sold are at time of sale, you kind of make these estimates. If your estimates are aggressive, you can be exceptionally wrong and that’s effectively kind of what happened there. For a variety of reasons they made the wrong decisions, the firm wasn’t lead, really, as well as it should have been. The firm was not led anywhere near as well as it had been led many decades before and its history, which is really what attracted Buffett to the firm in the first place.
Joseph Calandro: And then once the insurance results tanked, and [inaudible 00:42:05] we had the tragic September 11 terrorist attacks, so they were concentration issues, a variety of regulatory issues there too, there are a variety of things related to the core insurance business that Mr. Buffett corrected after he had bought the firm; and that’s really what led him to suffer the losses that he did there.
Tobias Carlisle: And what other case studies do you have of the application of these principles, the ones that you want to discuss?
Joseph Calandro: Well the flip side of the GenRe case is the GEICO case, which GEICO is to personalized insurance what Marvel and Disney are to media, I mean, it has just been such an absolutely resounding success. And given what they did, take automobile insurance, which most people would prefer certainly not to talk about, and through a very, very innovative and entertaining media campaign, really turned it into a strength.
Joseph Calandro: And, again, this is a really good example of my earlier comment you don’t make innovation a kind of a separate thing I and of itself, you try to find a way to do that in your core business, and then execute strongly on it. And GEICO under Tony Nicely is really the preeminent case study of that, especially in financial services; so that’s another one.
Tobias Carlisle: And Lou Simpson, who ran their equities or ran their investment side was also part of-
Joseph Calandro: Right.
Tobias Carlisle: That success. I was discussing on Twitter yesterday, Fannie Mae was one of those stocks that lots and lots of very well respected value investors had positions in Fannie Mae from very early on. And to their credit, I think most of them or at least the ones that I know of it … So Simpson, Munger, Buffett, and Peter Lynch and a few other guys had these positions on when that we’re going very well. And to their credit, as soon as their mortgage underwriting standards dropped and they sort of started aggressively acquiring new business, that was the point at which most of those guys sold out.
Joseph Calandro: Right.
Tobias Carlisle: Even though the stock then continued to appreciate for a number of years before the real problems became apparent. When it did and now it’s in conservatorship, which is sort of the government version of bankruptcy. Do you know the Fannie Mae story, at all, are you familiar with it?
Joseph Calandro: Yeah. I’ve read the books on it. And I remember them, they weren’t a client of mine but they were a client of a friend of mine. And kind of, when I poked into it, I mean, again, this whole field of structured finance where you’re just kind of creating financial products due to some regulation tax or other type of work around, I mean there’s, generally, no value associated with that, you’re just kind of shifting things across the balance sheet. And there’s currently ways to play it to make money or not, but those types of things I never found very interesting, I don’t like them.
Joseph Calandro: Clients of mine that have them on their balance sheet, I want them to hedge, watch them closely, because when these things go they go strong. And, unfortunately, Fannie Mae, Freddie Mac and a bunch of the other things certainly got caught up in that.
Tobias Carlisle: I know that you have a new book coming out in the next few years. You allowed to discuss it at all or are we … Not necessarily the content the book, I know that the book, there’s a very long review process for books of [inaudible 00:45:47].
Tobias Carlisle: The book is excellent.
Joseph Calandro: Thanks.
Tobias Carlisle: Well, I’m a little jealous or envious rather, I wish I’d written it myself.
Joseph Calandro: Thank you.
Tobias Carlisle: It’s a fantastic book. Can you give us a little taste of what the book’s about and when you expect it to emerge?
Joseph Calandro: Yeah, sure, no thank you for asking, I appreciate it. My first book called ‘Applied Value Investing’ shows how to apply value investing principles to corporate M&A and risk management, basically. What I try to do in my next book is to extend it from M&A and risk management into corporate strategy to corporate management.
Joseph Calandro: So we talk about things and we have a few case studies in there surrounding that and it’s going to be published by Columbia University Press, it’s currently in its second round of reviews; all of which have been very, very good. And the manuscript that you were kind enough to review for me has been submitted. So yeah, the next year I’m going to be in editing hell, as they say to get this thing ready.
Tobias Carlisle: What’s the working title, what are you calling it right now?
Joseph Calandro: The working title right now is ‘Value Investing In Corporate Management’.
Tobias Carlisle: And when do you expect it to come out?
Joseph Calandro: Expected publication is spring 2020.
Tobias Carlisle: Spring 2020, so that’s about a year away?
Joseph Calandro: About a year away.
Tobias Carlisle: Well that’s very exciting.
Joseph Calandro: Thank you.
Tobias Carlisle: And I’ll have to have you back on then when that comes out so can-
Joseph Calandro: I’ll hold you to that.
Tobias Carlisle: Well, I’d be happy to. We can go through it in some detail when that comes up.
Joseph Calandro: Okay, okay, look forward to it.
Tobias Carlisle: Well thanks very much, Joe, for spending some time with me today. If folks want to get in contact with you, what’s the best way to do that?
Joseph Calandro: Yeah, so my email is firstname.lastname@example.org. If you Google me, you’ll find my Social Science Research Network authors page and you can also get contact me through that, or my Gabelli Fellows page at Fordham, you get to contact me through that, as well.
Tobias Carlisle: And your 2009 book is ‘Applied Value Investing’, if you haven’t read it, you should because it’s excellent.
Joseph Calandro: Thank you.
Tobias Carlisle: Joseph Cassandra Jr. Thank you very much.
Joseph Calandro: I appreciate it, thank you, Toby.
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