In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Steven Wood discuss:
- GreenWood’s Investment Philosophy
- Constructivist Investing and Board-Level Activism
- Jake’s Veggies: Venom, Ecology, and the Power of Focus
- Case Study: Turning Around CTT, the Portuguese Postal Operator
- How Value Creation Comes from Balanced Leadership
- The Owner-Operator Advantage: A Data-Driven White Paper
- Key Behaviors of Owner-Operators Around the World
- Why Skin in the Game Changes Boardroom Dynamics
- ISS, Glass Lewis, and the Swatch Campaign
- Why Swatch Might Be a Once-in-a-Lifetime Opportunity
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Transcript
Tobias: I think we’re being livestreamed, which means this is Value: After Hours. I’m Tobias Carlisle. Joined as always by my cohost, Jake Taylor. Our special guest today is Steven Wood from GreenWood Investors. How are you, Steven?
Steven: Doing great. Thanks for having me.
Tobias: I put your description on our site as Distress Deep Value and Special Situations.
Jake: Try not to be offended by those labels.
Tobias: Yeah.
[laughter]Tobias: I’ll give you a chance to defend yourself.
Jake: Yeah. [laughs]
Tobias: What’s GreenWood? What’s the strategy at GreenWood?
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GreenWood’s Investment Philosophy
Steven: Well, I guess notably we haven’t converted to a quality and Garp shop, which is the-
Tobias: [laughs]
Jake: [unintelligible [00:00:44].
Tobias: Sorry to hear that.
Jake: Yeah.
Steven: So, that means I’m very hard headed. We are a group of investors that love to go off the beaten path. My mentor, Wally Carucci, his dad was a prime broker for Graham Newman. I think like Seth Klarman and a few folks would call nano-cap forgotten land Wally World. And so, it was looking for really random stuff. A lot of times, Wally and I would get involved not on the boards, but we would try to actually create a catalyst to move some of these small things.
And then, unfortunately, Wally passed away in 2013 when I think I had $4 million under management, $5, half of that was his. And so, I’ve just been building on top of that history. We’re like $150 million now. We still have that same sort of ethos, and what that means is like we’ve gone ex US, because there’s more interesting things happening outside of the US index, of course. And so, we’re actually like 95% ex US now. We’re still focusing on things–
Special situations have evolved a little bit. We’re no longer doing spinoffs, liquidations, those types of things. We’re doing things that we think have behavioral transformations happening, where something can go from turnaround to value to GARP to maybe even compounder. And increasingly, we’re trying to be one of the catalysts that restores ownership to management. We feel pretty religious about the vital importance of having owners represented on the board and in management, because it’s an observation that happened probably mostly from recovering from mistakes.
But the amount of people listening to this podcast that spend thousands of hours one specific name, it’s probably almost everyone that’s listening. If you compare and contrast that to the average director of the companies that they’re investing in, it’s a 1000x the amount of work that’s happening. And so, the whole origination of this conversation started in Vail when I was telling Jake in the audience, I was trying to compel more people to take board roles, because the companies need that level of stamina of focus and that sense of urgency as well that is not there without the skin in the game. So, that’s the evolution of GreenWood, although, we’re still keeping that special situations approach. Always looking for hidden things, places where we disagree with the market on quality especially.
And so, here we are as an ex US sort of– We call ourselves a constructivist investor. 70% of our portfolio, we’re now on the board or trying to field some candidates for the board. And so, increasingly, we want to have some visibility into the execution. It’s not just visibility. It’s actually some influence over the execution of the businesses, if that make sense.
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Constructivist Investing and Board-Level Activism
Tobias: Are there any names that you can talk about publicly that you can give us just as an example of your process and how it works?
Steven: I think I can talk about everything in our portfolio. So, the first company I went on the board of was CTT in Portugal, the postal operator. It had not grown for decades before. Revenue flat. What that meant was margins were compressing. We had a whole list of initiatives for the management team to do. It was a very polite series of meetings, but apparently, nothing was getting done. And so, I asked for a board seat. They welcomed me on in 2019.
To be honest, we worked with most of the existing managers there and existing board members and started a process where we attacked the weakest parts of the business. But the real vision was to turn the company into an e-commerce company. Most people don’t know this, because the US Postal Service is not a publicly reporting entity, but the postal companies generally capture most well over a majority of the e-commerce related deliveries because of the density that they have.
Portugal and Spain to an extension is at 1/5th, 1/6th of where the US is even today. I mean, it’s growing fast but– And so, we took this owner approach. We do have a few new managers. Well, now we have quite a few managers since 2019. But it’s that customer first approach and invest in the business. The company’s revenue went from basically zero to close to 10% since we’ve been involved and the margins have inflected materially.
The thing that I’m proudest about is the net promoter score which we’re going to disclose actually in a few months with the Capital Markets Day. But the net promoter score went from deeply negative to it is the best in the industry. We still have issues. When I go on Twitter, people still reach out to me and say, “My delivery man sucks.” We do a DM, I say, “Give me your address, we’ll fix it.” [chuckles] Because that’s how an owner thinks. It’s always sort of what’s the customer experience like. And so, it all starts with that.
But to be honest, even though this is special situations because there’s M&A, there’s some… assets that we’re doing, we’re selling expensive assets and we’re redeploying reasonably priced assets. There are typical special situations type buzzwords. But really our approach is I think at the end of the day, we will make a lot of money if the earnings reflect the progress.
And so, it’s a long and patient approach to the business. But instead of trying to get a valuation to return to the mean or something like that, we just want to build great assets that people want to own, because they’re actually fast growing and supported by earnings.
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Case Study: Turning Around CTT, the Portuguese Postal Operator
Steven: So, that’s our process. That was our process with Leonardo. The company went from, I think, one of the worst performing companies in the European defense industry to one of the best. But it’s based on fundamentals. It’s not based on return to mean valuations, if that makes sense.
Tobias: What was the problem with the revenue growth? They hadn’t put up prices or they– What was the issue?
Steven: There were two issues. So, parcels were basically not growing. They weren’t exposed to e-commerce really. Their network in Spain, in particular, was not set up for e-commerce. It was set up for B2B. There’s just no growth in B2B parcels anymore. It’s all e-commerce.
The second thing was they had a contract with the government that didn’t allow for them to increase prices fast enough on mail. And so, obviously, the management did 99.9% of the execution there. But we did work with the government, actually, to help them understand that the way to keep the mail network sustainable was to actually restore the pricing mechanism to that. Otherwise, the thing would have totally– There would be no mail, because you just couldn’t support 24-hour delivery with a 40-cent letter price. It wasn’t working.
It was a multiyear negotiation process, but both of those things have fixed. E-commerce is the is, for sure, the number one driver of the company right now. One of our investors actually was at Amazon Prime helped us a bit with how to get Amazon to even just launch in Portugal. When we started, Amazon wasn’t really even– You could buy in the UK and it could ship, but there was no next day 24-hour service. So, we took that responsibility on ourselves to get the market actually there.
I think Portugal is an afterthought for most international companies, but it’s very digital and it’s ripe for e-commerce, and so we proved that out. COVID helped us, obviously. I think our capacity in parcels has gone up something on the order of like 15 to 20 times since we’ve been involved. So, we’ve, for sure, taken quite a bit of market share.
Jake: Steven, when you come into a new company, a new situation, is it like the Tolstoy quote? I think it’s a Tolstoy about like, “All happy families are the same, but every miserable family is uniquely unhappy.” With these businesses, are they uniquely broken or is it actually more like they all have the same problems that they need to solve?
Steven: I think of it the opposite. But I got to warn you, I’m psychologically biased because I’m a man with a hammer and everything looks like a nail. My thesis came to me while I was writing this book that still hasn’t finished. It’s like my pet project that’s been five years in the making.
Jake: Toby, any thoughts on that?
Tobias: I have one too.
[laughter]Steven: Jake, my thesis is value creation is a balanced brain process. You need to be really strong top, that’s top brain, which is prefrontal cortex, bottom brain, which is the EQ marketing genius. Donald Trump’s a perfect example. He’s just the bottom brain. There’s really no top. And then, there’s left and right.
And so, my thesis, Jake, is all value creation requires that. So, they’re all happy families are the same, because they’re balanced. Normally, when things are breaking down, there’s a lack of balance. So, a really good example of that, is in the Spanish division of CTT just sticking on that, it was shrinking, it was burning cash for decades. The consultants that were there were basically trying to shrink it, trying to outsource everything to basically shove the losses onto franchise delivery guys. But you couldn’t win e-commerce in that regard.
So, we had to actually invert the process– Our new management team came in and said “We have really terrible quality of service. We are irrelevant for most people.” And so, he took a really customer forward approach. We rebuilt a network from scratch in six months, or he did, and then grabbed Amazon as a first anchor tenant and then was able to start getting Alibaba and a few other of the giants there.
And then, very, very, very quickly– Because everyone else was focused on this basically franchise model, we were able to replicate or build a network from scratch in Spain that had incredibly high customer service quality metrics. And so, it was actually pretty differentiated– Actually, it still is. So, anyway, when I come into a board or a situation that’s not going well, it’s normally a lack of balance of viewpoints, if that makes sense. And so, it’s to me, all bad companies are bad in different ways. So, it’s almost the opposite of Tolstoy.
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How Value Creation Comes from Balanced Leadership
Tobias: Let me give a shoutout. Let me go around the horn, give a quick shoutout and then let’s come back and talk about your paper, Steven. Petah Tikva, Israel. What’s up? Mac is in Valparaiso. Tomball, Texas. Cleveland. Bixby, Oklahoma. What’s up? Bendigo, Victoria. Early stuff for you. Chicago. Snohomish. Bellevue. Wilmot. Tallahassee. Lausanne, Switzerland. Philly. Rochester, New York. Havertown, Pennsylvania. Gothenburg, Sweden. What’s up? Bakersfield. Jupiter. Zurich.
Steven: You, swatch holders on the horn.
Jake: [chuckles]
Tobias: Toronto. Övfre, Sweden. That’s a hard one to say. I’ll read anything that’s on the teleprompter.
Jake: Yeah. Sound it out, Toby.
[laughter]===
The Owner-Operator Advantage: A Data-Driven White Paper
Tobias: Steve, you’ve got a white paper out about owner operators. That’s something that’s near and dear to my heart and to Jake’s, I would say. So, tell us a little bit about the paper.
Steven: Okay. So, thank you for this. I’ve been working on it since 2019. Why did it take so long, is I wanted to get it peer reviewed. The academic literature on ownership is pretty stale. There’s a lot of literature, but it basically just looked at Q-ratios and return on assets.
Tobias: What’s a Q-ratio? Just remind us of the Q-ratio.
Steven: A Q-ratio is the market price over the replacement value.
Tobias: Oh, I see. Okay.
Steven: And that used to be a well-used metric in the 1970s and 1980s.
Tobias: The old Tobin’s Q.
Jake: [unintelligible [00:15:02]
Steven: Exactly. Tobin’s Q. Yes. Now, Credit Suisse and McKinsey has a family index. But what I wanted to look at is not just families. I wanted to look at all types of businesses, including the ones that I’m on where boards or management team have significant stakes in the company. We chose 20, because that was more cross comparable to other studies.
And so, what I did is we scrubbed– It was 30 years of data on the performance of these. There’s about 450 basis points of annual outperformance if you just throw a dart into this asset class. Curiously, they underperform the late cycles. So, it’s weird. It doesn’t totally correlate to value, but it underperformed in 1999, massively outperforms in 2001, 2003, underperformed 2007, also underperformed 2019. And then, the performance comes back fairly materially.
But through the cycle, it’s that 450 basis points a year, which over time in America– This was the first global study. Because normally, they did S&P 500. They would do like a French index. There was a Swedish index one. The problem is S&P 500 inside ownership has gone from 3.5 to 1.5 in just in the last 15 years. And so, you really can’t do these studies anymore with S&P 500, because there’s no owners left at the S&P 500. And so, we wanted to look at the behaviors.
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Key Behaviors of Owner-Operators Around the World
Steven: So, we even looked at net promoter scores, we looked at Glassdoor metrics to understand employee engagement, we looked at their M&A behavior. We looked at all the behaviors. And some of the most surprising things were– Well, okay, let’s go with not surprising. Not surprising, they don’t give guidance. They invest in their business. They have significantly higher net promoter scores/customer satisfaction. One of the more surprising things was, and it correlates just as strongly almost as revenue growth that they truly stand out in is they don’t pay dividends. They don’t really do a lot of share repurchases.
Now, remember, this is 1,300 businesses across the world. So, because a lot of them are non-US, because there’s only about 160, I think US– So, in the paper, I break everything up by geography. And unfortunately, there weren’t a lot of Latin-American and African, so I just focused on North America, Europe and then Asia Pacific. And so, we separated all these behaviors.
To me, the interesting point is not do they outperform. Every study shows that they outperform. Well, actually, there is some doubt in the academic literature. To me, the question was how do they behave. That was the most interesting thing because I started this paper at the same time I got on the board of my first mandate, and so I was also self-examining what is it as an owner I’m going to bring to this company and where I was going intuitively the customer employee morale also drove some of the curiosity. So, I spent years researching these behaviors and then it took like–
Honestly, it took like two years just to answer the peer review. That’s why I really wanted to do this is, so that it enters the academic literature universe. Because to the academics this is largely an ignored topic, and to me and you, it’s incredibly important and for market practitioners. And so, that was the value. There was a lot of data scrubbing that we had to do to get this accepted. It was very gratefully accepted in the International Review of Financial Analysis. So, it’s coming out in July. There’s a link to it. It’s already public and I paid for open access, so that everyone can have access to it. We’ve linked it on our homepage as well. I’m sure you can link it on your show notes as well.
Tobias: We’ll do that.
Steven: Perfect. Yeah. So, I’m really excited about it. Also, I think what I’m really excited about is it’s a great time right now to invest in owner operators. Usually, there’s a valuation premium that’s been confirmed through decades of research. Right now, there’s actually a discount on owner operators through the index, probably partially because of the Mag-7 dominance, but there is a valuation discount looking at this better asset class. There’s 1,300 businesses to look through right now where people are co-investing alongside you and owning a significant amount of the business and managing it as such. So, I hope this message lands with some people.
We’re going to continue to update the data every year. Just getting it published was the first step, but then we’ll keep tabs on who’s in the index, how’s it performing, how are they behaving overtime and who knows what we’ll do with it one day. But I do hopefully it adds to this near religious zeal that I have to restore the link of ownership back to management.
Tobias: What sort of role do the large shareholders need to have for you to count them as owner operator?
Steven: In this, we just said they need to be on the board or in the management team. When I also looked at the type of owner– There was no way for me to actually look at families, although there’s plenty of family research out there. We looked at if a company owns it, if a government owns it, if a private equity firm owns it, if a venture capitalist owns it, what the type of person that was on the board–
Interestingly enough, if it was a company or a venture or a private equity group, they didn’t have any sector wide outperformance. You lost almost all your alpha. So, the alpha is in the manager themselves, the individual person with skin in the game, participating in the management or the board.
One of my favorite subjects is sort of independence of board members. Buffett liked to talk about independence and his idea was you have the capacity and temerity to tell a charismatic CEO, no, when something is going to destroy value. The way that you do that is you put your own skin in the game and you’re not dependent upon the board salary or the board position for your reputation. So, those are the two criteria.
So, this skin in the game is really important. I’ve seen it with me. I’m just one voice of 12 on Leonardo’s board, I’m one voice of 9 I think it is on CTT’s board. So, I don’t have a control position. For me, the ideas have to be sound enough to carry support. So, the quality of the idea is the only ability that I have to influence the debate.
So, my typical approach is when something’s not landing– So, for instance, were the first company and told to cancel shares from a share repurchase program. And there were some people who needed quite a bit of education about that because it’s– Especially in Europe, share repurchases are not looked at similarly to dividends, even though– So, dividends are like no brainer accepted. Whereas share repurchases is like “Wait, what’s happening right now?”
The way that I approached that debate was if it wasn’t landing, I needed to figure out another way to describe what something that is common sense to us, three. I needed to find another way to talk about it. But I wouldn’t give up. That’s the key. My skin is in the game. And so, just because the first conversation or second conversation didn’t lead to a yes, we didn’t give up. And so, that is that sort of stamina that an owner brings.
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Why Skin in the Game Changes Boardroom Dynamics
Steven: This is more speculation. I think the reason it works is when you have skin in the game, you treat the asset like your family, like you’re committed to it essentially. What that does is it brings you in the right brain. And so, it brings you into that whole brain management, because most boards are very left brain, KPI oriented. And so, that skin in the game does bring you over, I think, to the right and then you end up with a much more balanced view essentially. The best boards, unfortunately, it’s less than 20% of boards actually have active debates according to Harvard. But the best boards are–
Jake: The rest is just eating bagels or what’s the–
Steven: I have the stats. There’s an awesome HBR study. So, 46%–
Tobias: In those little sandwiches really sticks to the roof of your mouth?
Jake: Yes.
Steven: [laughs] So, 46% of boards are passive, 19% of boards are controlled by the CEO and only 14% of boards have mentorship relationships and only 12 of them have this relationship of a partnership. It took a few years at CTT for us to get there, but our boards are truly– They’re not tense, but it’s a– We are truly disagreeing and going in a massive debate. We have actually U-turned company policy within single meetings based on these debates.
That’s what companies should have. Unfortunately, only 25 of boards have that happening. That was with HBR. So, I’m guessing they’re probably even looking at best in class boards. So, I think there’s a significant unmet need to have ownership represented on boards.
Jake: Were you able to control for related party transactions? Sometimes there’s accusations where there’s economics being sucked out by a control shareholder by somebody who’s got a lot more power there?
Steven: So, in the academic universe, they’re like, “Hey, what are you bringing new to the table?” There have been studies, Jake, that talked about that– I think it was like more 1980s, 1990s. From that perspective, there’s a perfect weirdly U-shaped correlation to the ownership. So, the ideal sweet spot was I think around between 5% and 30% ownership where the controlling CEO, board member whoever it is, as an active check on them. So, when you get really low on ownership, the performance suffers. And then, when you get really high, also the performance suffers.
Jake: Corporate– [crosstalk]
Steven: I think that goes back to, speaking of the French company that we were talking about earlier Bolloré, it goes back to– You absolutely know on that board, no one is disagreeing with the found. And so, having that healthy ability to disagree is crucial.
I know this from Wally World from nano-cap land. There’s a lot of companies that are run by 30%, 50% holders that are really being mismanaged and are terrible. And so, you do need a healthy tension between stakeholders. Jake, there was also another study that looked at multiple stakeholders on board versus one. I think the sweet spot was three individual large stakeholders on the board led to that healthy tension and debate, actually. But I didn’t look at the related party thing necessarily for this one only because it had already been examined.
Tobias: Along the same vein, I’ve got a question here from one of the listeners. “Are there places where Owner operators are a clear disadvantage?? E.G. large family ownership in Korea?” He’s given us the example.
Steven: So, Korea hits into the study. Obviously, Asia-Pacific was the largest geography with obviously someone that’s 20% plus. When I looked at the last 30 years of data– Now, I cut the data in 2022. But when I looked at it, there was no relationship between higher levels and lower levels in performance. It was basically zero correlation between higher levels.
The Korean example is exactly the negative example that we were just talking about which is it’s almost always a full control situation where minority voices are totally irrelevant. I mean, not even considered. And so, you obviously enter into many of these where you’re trapped with someone that might not necessarily be “whole brain or best in class.”
It’s one of the major downsides. It’s why I think owner operators really deserve an active manager looking at at them as opposed to just buy them all, because there’s not– I would say, it’s not all great. It’s not all gumdrops and lollipops. Korea is a great example.
I’m an ex-US investor and so I’ve been watching Korea with great enthusiasm. I think the market is trying to take the steps that Japan took years ago. So, I think it should be on everyone’s watchlist that I don’t know if this closed behavior of the tribal are necessarily going to be there forever, because who knows with the political, how the political environment unfolds. But everyone is looking at the Japanese example with great interest. Because if your capital markets are constantly trading at a single digit earnings multiple by definition, your economy is playing with two feet handcuffed behind its back essentially.
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ISS, Glass Lewis, and the Swatch Campaign
Jake: Steven, any thoughts on ISS and Glass Lewis? Am I poking or waving the red flag at the bull here? [chuckles]
Steven: We always want their support, because so many indexes just follow their recommendations blindly. I think sometimes they can be quite thoughtful and sometimes their workload is so overwhelming that they can’t bring something thoughtful to the table. I’ll give you a great example, where I nominated myself for the Swatch Board. The annual meetings a week from tomorrow.
ISS said, “I, Steven, did not make the case for sufficient change because a separate analyst reviewed our materials.” The one thing I am committed to is always remaining friendly and constructive. Because I think if you’re getting into public fights, it’s by definition you’ve lost before you’ve started. So, we did not talk about the company’s track record. We just talked about the areas that we saw for improvement.
And so, what’s very strange, Jake, is ISS’ report, which was mostly done by a separate analyst, calls for dramatic change. Vote against all incumbents, vote against the company, say no, no, no, no, no, no, no, no, no. And they say, “Hey, we need more independence on the board.” And then, here comes Steven, an independent candidate, but because I didn’t make the case for change, they didn’t recommend for me.
Jake: You weren’t radical enough, basically.
Steven: I didn’t trash talk the company which I don’t want to do frankly. And so, in that case, I think it was probably just not enough. I don’t even know if they talk to each other. So, I just think that their workload is unbelievable. I just had a conversation with a very prominent governance team earlier today, and they were talking about how they have hundreds of meetings per week during proxy season. So, I think it’s an unusually high amount of workload to put on that team to be thoughtful in every case.
So, we have this 501(c)(3) called the Builders Institute. It’s dormant, but once my book comes out called the Builders, we’re going to stand it up. One of the purposes I think, I just don’t know how to execute this at scale, would be to come up with some proxy advisory function that would look at independence the way that Buffett does and the way that you and me do, as opposed to the way that like best practices do.
I will end the Glass Lewis and ISS’ discussion with this. I’ve talked with BlackRock, Vanguard, all of these governance teams. Increasingly, they are not following the recommendations. So, there is an open mindedness to another way. As the world robotizes, as the indexes robotize, I do think that there’s a need for some type of advisory, the question is is what are the principles behind that.
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Jake’s Veggies: Venom, Ecology, and the Power of Focus
Tobias: JT, top of the hour. Do you want to do some vegetables?
Jake: Yes, sir. This one hopefully will tie in with Steven and his strategy a little bit. Although I [chuckles] can’t always match him up, but I tried this week. So, this is all about venom, because we always try to dip into the natural world where we can steal Mother Nature’s secrets for our benefit. But picture this.
A rattlesnake slithers across a sunblasted island in the Gulf of California. It’s not looking for trouble, just dinner. But what’s in his venom will tell us a much deeper story.
So, researchers from the University of south Florida studied 83 snakes on 11 remote islands in the Gulf of California. Their question was very simple. Does ecological complexity drive venom complexity? So, the intuitive answer is probably yes. Like, more prey equals more problems, equals more biochemical tools to solve them. But nature had other ideas here. On the bigger bustling islands, the venom didn’t get more complex. It got simpler. So, it’s less diluted, sharper, distilled, but for a more narrow target set, like a scalpel instead of a Swiss army knife.
So, venom is really about fit. It’s an evolutionary product market fit. And biochemically, venom, if you don’t know, it’s a pretty wild cocktail. There’re neurotoxins, which are like nerve blockers, which basically will freeze something when it courses through the system. Hemotoxins, which are blood disruptors, and then myotoxins, which are muscle breakers and then there are enzymes that are in there that speed up all of this and spread the chaos even faster. So, each molecule in venom is like this little targeted missile. It’s not a blunt instrument at all. It’s like this nanomolar scaled precision tool. But they’re very expensive to make. And so, it costs a lot of metabolic currency to create this. And nature keeps a very tight budget.
So, if a snake mostly eats one kind of lizard, it evolves venom tuned like a sniper rifle really to that lizard’s biology. So, complexity for complexity sake is not how evolution works. It’s lean, it’s brutal, it’s focused. And on islands that were teeming with a lot of prey variety, the snakes didn’t go broad. They went very deep. And because there’s a very high return on biochemical investment by being a specialist. So, if you’re only dining on lizards, don’t create bird killing toxins. This is called in ecology, adaptive streamlining. And in business, we might just call it focus. And in investing, it’s knowing your edge.
So, the key idea here really is like every strategy is a kind of venom. It’s a tool designed to exploit a particular inefficiency. It’s probable that a lot of people make the mistake of trying to own every kind of toxin. You want to really want to be able to define what your edge is. Maybe it’s time horizon, domain expertise, the information, temperament, analytical lens. And match that venom to your ecological niche. Don’t hunt for birds basically, if you’re a lizard eating investor.
So, here’s a little checklist to help you find your venom. What inefficiency am I consistently able to exploit? What conditions must exist for my strategy to work? What kind of prey, business, asset, setup, whatever it is, am I built to target? Can I explain my venom in one sentence? And when does my strategy break down? When am I not built to hunt?” The reason I was alluding that this connects with Steven is because he’s doing something relatively niche. He has a particular thing that he’s looking for and he has a particular skill set that he’s bringing to the table. So, it’s a bit of his own venom for a certain type of lizard.
Tobias: Good one, JT.
Steven: Can you also correlate that to return on time? So, if I’m going to specialize on that lizard, you can actually base– Is it more efficient metabolically on energy, Jake?
Jake: Yeah. Yeah, it’s more efficient to have the simplest venom that’s called for to be effective rather than maintaining a very complex roster of venom. It’s just going to be more energy inefficient to do that.
Steven: So, it’s funny, because when you look at 1,300 companies together, very few things stand out from a macro perspective in terms of correlations. And then, you get into individual things, and every little thing needs its own little thing. But I will say, if I correlate it back to my white paper, the things that are the most reliable is customer satisfaction, revenue growth, expense growth and employee growth, and then not doing M&A, not returning capital to shareholders. Those are the primary sort of–
If I had to think about like an island with a lot of heterogeneity, I’m going to focus first on customer satisfaction and employee growth, basically. And that’s going to be my killer app. But then, if you look at it underlying– For instance, TransDigm is in here. Deeply negative net promoter score. They’ve optimized other things and they’ve done very, very well, but their customers absolutely hate them.
[laughter]Steven: So, it’s a great example. I like how you said the venom gets simpler the more heterogeneous the environment is. That makes a lot of sense, actually.
Jake: I found it to be counterintuitive, which is why I was interested in this piece and writing it up more was, I would have thought, lots of different species to target while you want to be able to maximize, taking down whatever you come across. So, you need to have every toolkit available to you. And that would probably confer evolutionary survival advantages. But no, it turns out Mother Nature wants a better ROI than that. As long as there’s a niche that’s available to be exploited, then that’s what she’ll do.
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Why Swatch Might Be a Once-in-a-Lifetime Opportunity
Tobias: Steve, can you tell us a little bit about Swatch? Because that’s a name that many people will recognize, and tell us what’s going on there.
Jake: Synchronize our Swatches, Steven.
Steven: Old Uncle Warren told us that net-nets were dead. It is actually a net-net in a 7.5 billion Swiss franc company. It’s been left for debt largely.
Jake: Is that inventory, or is it– Where’s it showing up in the net part, AR?
Steven: Yes, it’s mostly inventory, Jake. But what I’m not doing is a third of that inventory is in gold and diamonds which is at– And the gold price is like half the current market price. So, if you actually adjust it for current market values, it’s even more of a net-net or more of a discount– Yes, exactly.
So, it’s largely left for debt. It’s 25% short right now which if you take out the family’s ownership of 25% of the shares is like 33%, something like that, 34% of the flow is short. According to Cap IQ, there’s one buy and then there’s 20 holds and shorts on it. So, it’s largely been abandoned.
As I was thinking about your venom story, the thing about me that gets me most excited in terms of that single lizard is misunderstood quality. Swatch, even though it’s been left for dead and the results look– The revenue is at a 14-year low. I mean, the profitability’s not doing much better. There’s a lot under the hood that is really incredible. In 2010, this watch from brand Breguet, and Breguet outsold Patek Philippe and then Omega outsold Rolex in 2010. Most people, if you tell them those two things in the watch industry would say, there’s no way, because the memories fade fast. But these brands all have two to three hundred years of history into them.
One of my favorite people that I’ve met along this journey, I’ve met probably six or seven dozen people in the industry are former managers at this point. It was a Rolex advisor. And he said, “90% of what they’re doing is great. And then, they just mis-execute the final 10%.” I feel like that’s a perfect analogy for a lot of the group. There’s a lot happening that’s actually great. There’s a slight mis-imbalance in terms of the brain skill set I see if we go on to go full geek on it. But because of the amount of people that were encouraging this, I had the courage to nominate myself for a director in March.
The annual meeting is a week from now. The board, I don’t know who on the board, but the board just said not to vote for me. Even though that looks like it’s hostile, I maintain the friendly approach. What’s happening is under Swiss law, so we own half a percent of the votes. But we also joined with another fund that owns a couple percent that’s all been publicly out there. And under Swiss law, if you own half a percent, you can add items to the AGM agenda. We requested specifically a separate class of vote where it’s basically what the institutional share class is. The family owns a few percent of that.
Under Swiss law, they are required to hold a specific vote of those shares if requested by a person like me, the company decided not to do that. So, I’m sure I’m going to lose next week, because the company’s not honoring Swiss law. But I think it’s okay, because the amount of funds that we have been in touch with as we have been obviously campaigning for the spot, I think the momentum for change is dramatic. And so, I think next Wednesday, if I lose it, probably it won’t be the end of.
Long story short though, obviously, it’s a watchmaking business. Half of their revenue on the high end, half of their revenue on the entry level. They’re doing absolutely phenomenally well on the entry level. The problem is they’ve been competing against smartwatches. And so, those segments go down a few percent every year. So, they’ve been taking market share in those segments, but they’ve been really difficult categories.
Combined with China’s been pretty weak and China tends to skew on that more entry level, even though Omega is the number one watch brand in the country, thanks to Deng Xiaoping. And also, thanks to Swatch. They were building stores when they couldn’t even sell watches. And so, emerging markets have had an impact there as well.
I was in the FT last week and talking about this. To me, for luxury brands, this is a once in a lifetime opportunity. You get luxury companies trade below book value 1% of trading history, of that you’re at basically half of book value right now. You’re at 60% if you use GAAP, but you’re really at 50% if you adjust for the fair market value of gold and the real estate. So, I don’t think–
The company’s super, super conservatively structured, so the margin of safety is insane. And to be honest, I don’t think it has to change very much. I just think that there’s a bit of external, I say, fresh perspectives, but a bit of external help can go a long way in improving the execution here. So, hopefully, years from now, we’ll be talking about another success story. [Jake [chuckles]
We’re pretty committed. We’re committed to both the friendly route, but we’re also committed to seeing these brands go back to their former potential. They used to own over half of the luxury segment of the whole Swiss watch industry. I think they’re well less than 10% today. So, it’s amazing how other brands have built their machines largely based on marketing. They make 80% of a Breitling. And Breitling is crushing, is taking a lot of share through the marketing machine and the approach that it has with KOS.
So, I hope that’s not boring, but the highlight is net-net 200-year-old to 300-year-old brands that aren’t going– They own Harry Winston, the retail brand. So, they don’t own the diamond mine that got separated a while back. But Harry Winston on its own could probably fetch the entire price of the company at this point.
This brand, Breguet does probably 150 to 200 million of revenue. They don’t disclose it. Bernard Arnault offered $4 billion for this one brand. So, it’s like 2% of revenue and it’s half the market cap. So, there’s just a lot of latent potential hidden within this group. I really like the CEO. I’ve compared him to Steve Jobs, but he’s a super creative person. I think if he had like a Tim Cook type character, the operating model would sing, because it would be that sort of balanced approach. So, that’s the setup for it. But not every day do you see a net-net in the $10 billion market cap space. [laughs]
Tobias: I’ve got a few questions about the family and the product, basically. One is obviously there seems to be this movement towards smartwatches. Does anybody get a smartwatch and go back to something like Swatch or one of the other ones?
Steven: Absolutely. What I see is like I wear an Oura Ring. I wear a mechanical watch and I wear an Oura Ring. And Oura sold $500 million in revenue the other last year. So, one of my ideas that I’m personally dying for, Tobias, is a band with the light technology, but then the 200-year-old mechanical piece sitting here, so I can get rid of my piece of plastic on my finger.
Tobias: Yeah.
Jake: It seems pretty doable, doesn’t it?
Tobias: Yeah, that seems like–
Jake: I think warn factor wise.
Tobias: It’d be nice to have a little disc that just fits underneath the watch, so you don’t have to– So, you can wear whatever watch you want and just stick on the– [crosstalk]
Steven: What I’ve noticed in Europe more than US, US people wear more Oura Rings. But in Europe, they’re wearing the Whoop bands. And so, they have their mechanical watch one hand and then they have their Whoop band on their other. So, for four years now, Apple watch sales have declined. So, this trend is largely abating. Part of it is because Gen Z does not want a smartwatch. So, Gen Z in this very famous study done by Watchfinder–
Jake: It’s like, you have to look up from your phone. Is that why?
[laughter]Steven: I think it’s because they’re bombarded by technology, and they do not need another notification. Look, we’re in the market. Do you want notifications at all hours of the night? This is like your job. Of course, you don’t. So, the Gen Z in this Watchfinder survey is four times more likely to spend on a mechanical watch than any other generation. So, what I’m super encouraged by are these long-term demographic tailwinds in your favor. But guess what?
Besides Rolex, Rolex is the king of the industry. But the number one watch brand that Gen Z wants is Cartier. Well, first of all, it’s incredibly well run. No criticism on Richemont, but it’s a marketing machine. They are leaning into celebs or they used to. They’re pulling back right now, but they had Taylor Swift and Timothée Chalamet sporting their watches quite a bit. And so, you have to update your marketing playbook for the influencer world. You have to.
And funny enough– Actually, Harry Winston, I’m reading his biography right now. Harry Winston built his entire business on getting or decorating red carpet celebrities. It was even before it was like trendy to loan it out or at that time, even celebrities would even spend- Elizabeth Taylor wore most of her own diamonds. She didn’t take loans.
Jake: Just selling her wedding rings would probably be a fulltime line of getting married that often. [laughs]
Steven: Exactly. She was very well decorated in both Cartier and Harry Winston diamonds. It’s interesting that Gen Z prefers not as much like a Submariner like– Obviously, Submariners are an iconic model, but Gen Z prefers a fashion/jewelry-oriented model. Their brands, Breguet and Blancpain and Jaquet Droz in particular are literally heart of the runway for now.
A $30,000 watch is not affordable for many in Gen Z, but it is something to aspire to. One of the fastest growing brands in the last decade was Royal Oak. I’m sorry, Audemars Piguet which has– it’s basically a mono brand of the Royal Oak. It starts at $30,000. So, people are saving money for these. Actually, there’s a whole world of people out there that track their watch portfolio on a daily basis, like we track our stocks. It’s a very large universe. So, you can track real time how watch prices are doing. Problem is is that the macro data is not as reliable as stock data unfortunately.
Tobias: I look at that Rolex index to see how the top end consumer’s doing.
Steven: Yeah.
Jake: How much did that correlate with crypto though?
Tobias: 2021 was the peak, it’s come off a lot.
Steven: Yeah. So, Rolex is a fascinating case study. Tobias, I think you and I first started chatting around Fiat and Ferrari. Ferrari is when I really learned the playbook. You can manufacture scarcity. Ferrari has always done it. What happened in 2018 and according to this senior Rolex advisor, they honestly don’t even know how it happened. But the Submariner secondary values eclipsed retail prices, and then demand 10x once that happened.
So, once your expensive habit is actually something you can possibly make money on, demand unlocks into price agnostic. And so, you can do this. And for Ferrari, which has five-year product cycles, it only took them one product from 2008, 2009 where they were not doing well with residual values. They were controlling it, but they were not strong. By the time they IPO, and I think it was 2017, the residuals were largely breaking at a premium for the base range.
Ferrari did it in five years. I think a watch company can do it in far less than five years. Anyway, it’s particularly easy when Breguet– For instance, this is your crown jewel brand within the group I think. But Napoleon, Marie Antoinette, Winston Churchill all had one of these. It’s only like a couple percent of revenue. So, it’s actually a perfect laboratory to try what I would do out on. And so, it would be amazing to be able to do this. I don’t think a luxury strategy is that– It’s not rocket science. It’s fairly easy to implement.
Actually, the company is already moving in the direction of having all the assets it needs in place. It’s been building out its store network. It’s going to have the perfect footprint for a loyalty framework. So, they’re already moving in all the right directions. It’s just a matter of how you frame the strategy, I think. Not frame, but there is some go to market execution that’s necessary. But it’s not like I’m not asking for a 180 here. You know what I mean?
Tobias: We’re getting close to time. But I have a question. If you’re net-net price and you’ve got these pretty fabulous brands that have clearly got some brand value which is just not being realized at all if you’re trading at a big discount to your net assets, what’s the attitude of the family to this? Why aren’t they more open to assistants outside directors?
Steven: That’s a great question. I don’t know the answer to the second one. The attitude though has been the CEO has taunted the market that he’d like to take it private. I don’t believe that is actually what he wants to do. I think it’s defensive-reflexive statement based on like his observation that I agree with which is like, this is incredibly cheap. They have bought some shares in the secondary over the past 12 months as it’s come in. But I don’t know why they are more and more closed.
Former right-hand men of the founder that I’m friends with, everyone has gone in and tried to make some suggestions, and it’s largely been met with, “Thank you very much.” Why do I have the courage to do this is I’ve been working for a year establishing a relationship with them. I think half of them know that I come in peace and I really only want what’s best for them. We’ll see what happens.
To be honest, we don’t really do campaigns, Tobias. But it’s my first time where they’re recommending against me essentially. So, it’s new– Honestly, I’ve seen some comments on news articles that people think I’m doing this for ego or publicity. The opposite, I would love to not see my name in the news every time I wake up. I actually hate that part of it. But I think that– Well, I don’t even want to talk about the sum of the parts analysis, because it implies that I want to break up the company. But let’s just suffice it to say, in a net-net with luxury brands, it is a once in a lifetime opportunity. So, it’s enough to make you want to do the work on it. So, anyway, I appreciate you taking an interest in it.
Tobias: Well, that’s good timing. Steven, if folks want to follow along with what you’re doing or get in touch with you, what’s the best way to go about doing that?
Steven: Well, my DMs are open on X. So, that’s @gwinvestors. The website is gwinvestors.com. And every website inquiry comes to me personally. And then, my email is wood@gwinvestors.com. I try to be very responsive to pretty much everyone.
This is going to sound so cliche. I really think that like every voice matters. I think the whole premise of my book, is that everyone’s really good at something, back to the venom part of Jake’s of the podcast. So, the right a strategy in my opinion is figuring out what someone’s good at and making sure that they apply that skill set to that area. So, I love hearing from everyone, because–
Well, 80% of insights come from looking at a problem through a totally different lens. So, the more information that people want to share with me, even if it’s nasty, it’s really informative.
Tobias: Oh, that’s great.
Steven: So, thanks for having me.
Tobias: Steven Wood, GreenWood Investors.
Jake: Keep doing the lord’s work of capitalism, Steven.
Steven: You told me that in Vail. And to be honest, look, doing a board right is hundreds of hours a month. So, when I tell people that they should consider doing this, it’s not lightly. It only works for us because we put 20%, 25% of our capital in these positions. My return on time is married to the capital. It’s a tremendous amount of work.
But it is incredibly gratifying to be able to take things that people have given up on a 500-year-old postal company and turn it into the fact we’re the fastest growing logistics company, I think– well, I know in Europe, but I think even in the world. And so, I don’t think that could have happened without a few new characters arriving to the scene. So, it’s really fun to have that type of impact.
Tobias: Yeah. Congratulations, Steven. Thanks, folks. We’ll be back next week.
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