Value Investing’s Renaissance Man

January 25th, 2024

Friends,

I am excited to share this “Fireside Chat” with Jeff Gramm, General Partner of Bandera Partners and author of “Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism”, that took place at our second annual Ideas & Networking Conference in New York City on September 21st, 2023.

I have known Jeff for nearly 15 years, and he is truly value investing’s Renaissance Man: a thoughtful investor, fantastic writer, excellent teacher, and a good friend.  We had a wonderful conversation in September that I know you will find of value.

On a similar note, it is my understanding that @FocusedCompound plans to launch a series of podcasts based on Jeff’s book.  It would be worth keeping an eye out for this.

I hope you enjoy this discussion as much as I did.   Good luck in 2024!

Best Regards,

William C. Martin

 

Topics in this Issue of An Entrepreneur’s Perspective:

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Interview with Jeff Gramm: Value Investing’s Renaissance Man

Let’s rewind to the beginning. Your father was a very famous senator back in the day when budgets were occasionally balanced. I think he was responsible for a big part of that. What was it like growing up in your household? What were dinners like? Did you discuss politics?

My parents are both economists. My brother is an economist. His wife’s an economist. We talked a lot about money. My parents were both academics and I do feel it was a very academic household. We didn’t really have dinner together that much, though. Both of my parents worked in government, and they had pretty long hours. I remember that I would sometimes watch C-Span to see when Senate session would end, to see when he’d be coming home. When they were in session I could play around, and when the session ended, I’d be like, “Uh oh, they’re done, they’re going to head back. I have to clean up.” I remember being around when he would talk politics with other people. I would go duck hunting with him and his buddies. And I was a fly on the wall, which was of course interesting. But we didn’t discuss that stuff at the dinner table.

Is he still doing well? I sometimes read his articles.

Yes, he still writes for the Wall Street Journal. He still works full time at a private equity firm. He published a book last year and is finishing up another one right now. He was probably traveling 200 days of the year, pre-COVID. So COVID was a real system shock for both he and my mother. They went from being on the road all of the time to being stuck at home.

What got you interested in the stock market? Did they invest? Was that a topic?

No, growing up in DC, I really didn’t have exposure to business. My background was very much not the typical investor background: I didn’t get hooked on investing because I bought a stock when I was nine. I went to business school; I had never heard of Warren Buffett until I got there. I didn’t really know what investing was versus investment banking. I took investing classes and it really clicked for me. I took Security Analysis with Joel Greenblatt and this whole idea that there are what he called 50 cent dollars in hiding out there that you can find with a little bit of work, was just a very compelling idea.

What was the path to ultimately starting Bandera and the fund?

I came out of business school in the hedge fund boom years – the early aughts. I went to work for a merger arbitrage fund called HBV Capital that was bought by Mellon Bank and then became a large, $1.3 billion multi-strategy fund. That was big in those days! I worked on the distressed team. Distressed investing is actually a great way to learn about business. You learn about what not to do.  Operations are important. Valuation is extremely important. Trading is important because the positions are not liquid. You learn about leverage and activism and workouts. It was a great introductory course in finance. From there, my boss and I, the head of research, Greg Shrock, launched a fund called Arklow Capital. Then I left there to do Bandera in 2006, it’s been 17 years.

Talk about Bandera’s strategy. Do you short at all or is it all longs? Do you have a partner?

Yes, I have a partner, Greg Bylinsky. Basically, it’s concentrated value, 15 positions. There’s a lot of funds that do exactly what we do. We concentrate on our best ideas and try not to be wrong – it’s that simple. My previous two jobs before this were both at long/short funds focused on distressed. I never really got on board with shorting.

How did your approach evolve over the years, you’ve been at it for a while.

I think most value investors, the longer that they do it, they become a little bit more allergic to bad governance, a little bit more allergic to low quality. I think you tend to veer more towards higher quality and growth. One thing that I’ve learned is to always try to exploit a wide universe of ideas. We try to do lots of different stuff. We do special situations, we will do litigation. We try not to be too focused on any one niche, which is interesting because in the capital allocation world, people really want you to have a specialized niche. If I came to you and said, “I only do franchise restaurants, I’m long/short. That’s my focus and I know it inside and out.” That’s a great pitch for raising capital, but it’s not a great pitch for deploying capital and generating great returns.

You also taught a class at Columbia Business School. What were some of the key things that you focused on in the class?

I taught a class called Applied Value Investing for seven years. The reason I did it is: 1) they asked me, and 2) I stutter. I thought it was this golden opportunity to do something that would be a real challenge for me personally and that would help me work on my speech fluency.  I didn’t realize how much I would learn about investing through teaching it.

I’m going to teach another class starting in 2024. They’ve given me the Shareholder Activism class and I will be teaching that going forward at Columbia. I look forward to that.

It is very interesting to engage with young investors. I think about investing as a very, very, very simple thing. You try to think about a business like it’s the gas station around the corner that someone has offered you for sale, that was the mantra for the class. We would look at a new company every week and we would try to keep it simple. We try to help the students wrap their minds around it. I really saw how people want to develop a narrative based on their preconceived notions. I saw lots of bending of reality to fit their needs. People would come in with a thesis before they really did their research, and then they would do the research to match that thesis. I feel, as investors, that’s the thing that we always are trying to fight against. You’re trying to approach a situation with an open mind and understand it, without a lot of biases. In teaching, you really see how the students were really predisposed to bend reality to suit their needs. They would come in with each assignment and they knew what they wanted to prove.

That’s really interesting. Is value investing cyclical, or is it a dying art?

There are still people out there generating good returns. I still think it works. We’ve had a pretty good run. A lot of my peers have had good runs. I think, in the end, there’s always opportunity out there by doing just a little bit of extra work and a little bit of extra research. I don’t think it requires rocket science. When you talk about a situation like Ambac, it’s not super complicated and there are a host of reasons that people aren’t looking at it.

Have you looked at the Ambac balance sheet yet?  It is far from simple!

There’s a host of reasons that people aren’t looking at it and you can still find opportunities.

Has market structure changed?  Pod analysts seem to be everywhere, is that good or bad?

I’m not really sure. I’m not great at the big thinking in the way that you are. One thing that I’ve always liked about you as an investor is your ability to take a step back and look at the big picture. With the value ecosystem, I’ve kind of given up on trying to systematically figure out the location of the opportunity. I’ve really worked on refining my filter where I can process a lot of ideas quickly. The funnel isn’t important.

Do you have a very defined list of parameters or are you just constantly looking?  Why does one thing jump out at you versus another? Can you quantify it?

I just look at everything and I try to look quickly.  I’ll even sometimes look at lists, ordered by market cap. It’s not why things will jump out. It’s that when you look at something for an hour, is it worth any extra time? To me that’s the most important part of the process.  That’s a very underrated part of investing. But to your point, I don’t know. The one thing that I’ve noticed is that, if you’re looking in the $50 million to $200 million market cap range, there’s tons of people out there researching those stocks. You’ll have some dinky stock that you think is obscure, yet everyone is looking at it. Then you’ll find an $800 million company that literally feels like no one is looking at it with a critical eye. And so, I don’t know about systematic areas to look.

Do you think sites like Seeking Alpha have negatively impacted alpha generation for small cap and value investors?  It seems like so much more information is now available, making it harder to get an edge in these areas.

For me, I find I’m often looking for collective misjudgments. I’ll give you an example. I was looking at a company called Burford Capital (NYSE: BUR), which does litigation finance. It’s a big industry. If you’re a multinational corporation and you’re going to sue another multinational corporation, but you don’t want to have to pay for it, they’ll fund you or they’ll buy a portfolio of litigation claims from law firms. They’re the biggest player in a competitive space.  We had been involved in this multi-year litigation in the Delaware Chancery Court. I got a little interested in the litigation ecosystem. Burford was a heavily shorted stock. There was a short report by Muddy Waters, with the idea that it’s a house of cards and all the numbers are fake. I tried to figure out what was going on. How does the business actually work? Through our litigation, I met a lot of people who were professional finance litigators. It’s like the hedge fund business.

What kind of returns do they underwrite to?

20% to 30% IRRs. These are pretty crazy returns. The point that I was going to make about collective misjudgments is, when I called all of the experts in the field, they were all extremely negative on Burford. They would go on and on about how it’s a crowded space: “There’s lots of guys doing this.” “There’s issues with Burford’s particular investments.”  When you got down to it, though, the conclusions were bullish on the stock. I would ask, is Burford going to be here in five years? “Well, yeah.” Will they be here in ten years? “Yeah.” Will their returns be in a similar range. “Well, yeah, maybe down some, not a ton.” If you could buy their existing book for $1.5 billion, would you buy their book? “Oh, yeah definitely.” Would you buy the stock? “No.” You know, the stock is valued at $1.5 billion. “Oh really?” I had that conversation like ten times!

Does it trade on a multiple of book? How do you value it?

I valued it like that. At the time that we bought it, they had a big claim on a litigation involving Argentina’s nationalization of YPF, which was essentially being valued at zero. They recently got a big win in court, so it’s a little complicated now. But it basically trades at what I would call book, with the caveat that they have this $6 billion judgment which is a potential windfall. However, they have to enforce and collect, which won’t be easy. The point being, in investing, sometimes it’s not so much about finding the secret of a stock that a kid on Seeking Alpha is going to expose. It’s more about finding a collective misjudgment. I thought Burford was an example of that.

Can we talk about Boardwalk Pipeline? Loews (the company backed by the Tisch family, not the home improvement retailer) controlled Boardwalk Pipeline and took out the minority holders at a very low price. It was a pretty aggressive maneuver. Reputationally, a real negative mark. Jeff, you took them to court and won. Is the case still going on?

Yes, we won our case and then lost the appeal. However, you don’t really lose, it goes back to the judge. It’s an MLP, so you’re talking contracts versus Delaware corporate governance. They arguably had a contractual right to take this company that they controlled private. The market thought that the Tisch’s would be honorable and do the right thing and they did not. There was a peculiar scenario where they did this deal, they got sued, and then they settled with the shareholders. However, the settlement from the class action suit did not get approved by the judge before the closing of the deal. They asked the judge to allow that to happen, and the judge wouldn’t allow it.

Therefore, we concluded that, “well, we can go buy more units, we’ll get our cash out after three weeks. We can make a spread and then we try to fight the settlement because it’s a bullshit settlement. We thought they didn’t have the right to do this deal. I thought they behaved dishonorably. The deal closed in July. The hearing was in September. We stepped in and sued to block the settlement. The Judge agreed with us, and he allowed us to step in to be the new lead plaintiff in suing Boardwalk. The judge eventually awarded shareholders essentially $1 billion after interest. The appeals court reversed the ruling.

What percent upside is that?

If you had just bought at the deal price, it was about 60%. We were involved a little earlier, and had slightly better returns, but we certainly misjudged Loews’ willingness to abuse unitholders, so maybe we got lucky on that part.

Right, over three to four years?

Three years, but you did get that cash back immediately.

You had a little litigation stub. The IRR is really high.

One interesting thing about the suit is we pierced attorney-client privilege. There was a lot of bad behavior by Loews’ counsel and especially by Loews. They would play their lawyers off of each other to get the result they wanted. The Appeals Court, in my opinion, was very sympathetic to all the big law firms involved. Now the case has gone back to the trial judge. We’re hopeful he will send the same result back to a different appeals court, but I don’t really know what will happen. The whole experience has been really fascinating, but we might end up making more money from Burford than we ever make off of this litigation. One big takeaway for me from this process is how good the Delaware system is. We weren’t happy with the appeals ruling, but I’ve been really impressed by everyone in that world. Our lawyers, the judges, they’ve all been great. The Twitter case was another example – amazing job by the Chancery Court judge in that case.

Jeff is also the author of “Dear Chairman: Boardroom and the Rise of Shareholder Activism,” which is a wonderful book. As I mentioned earlier, even Mr. Buffett has given it accolades. Tell us about that book.

Yes, it’s been seven years since it came out. The Economist just published a list of the best books about boardroom battles in case you missed the HBO show, Succession.  It’s an unbelievable delight that people are still talking about it and writing about it.

It took about nine months to write it, and it was a pretty brutal nine months. I would wake up at 5:00 AM and work until work time and then again after dinner until about 1 AM.

I love the Loeb and Carlo Cannell stories. What’s your favorite story or two from the book? There are so many characters.

I think the stories on Ross Perot, GM, and the corporate raiders of the 80’s were my favorites. So much good material for me to write about.

I highlighted that section on Perot while reading your book. He’s pro-choice, pro-gun, pro-balancing budget, and a protectionist.  Why don’t we have this candidate today?

One thing he did when he lived in Texas, is he led this big campaign to de-emphasize high school football because it distracted from academics. This is a man who will say what he wants, regardless of the public opinion. I thought the history of GM was fascinating.

He sold EDS to General Motors (NYSE:GM), became the largest shareholder of GM and went on the board, only to discover it was a total mess.

As a good board member, he was a huge pain in the ass. As a normal corporate board, the rest of the board wanted to get him out. So the company bought him off of the board.

At around twice the price of the stock?

This was a real come-to-Jesus moment for all of the GM passive shareholders. For years in this country, and it’s still true to a certain extent, there was this idea that if you’re a passive owner and you don’t like what’s happening, then you sell. You don’t raise funds and sue the Tisch family. Who’s the jerk that wants to sue the great Tisch family? Then this event happens at GM, which is the stock that every institutional investor had to own. This was a real moment where they all realized, “well, the blood’s on our hands.”  We let this happen and allowed the board to think we wouldn’t care. It’s our fault that they thought that.

The chapter also goes into the history of GM. It’s fascinating how so much of business history flows through General Motors. One interesting tidbit is the history of the corporate pension plan was really defined at GM. The modern pension plan where they invest in a diverse basket of stocks – GM was the first one. There’s a lot of interesting history in that chapter.

If you had the power to change rules, bend rules, or take away rules, what would you do?  You’ve seen so much both from inside and outside of the boardroom. 

That’s a great question. It’s interesting, I wrote this whole book that tries to be prescriptive and it can’t be. As a lot of us know, the real key to governance is, do the directors care? Do they have the right fiduciary mindset? Do they put in the effort. There are no real best practices for that. There’s no board on paper that’s a sure bet to be the right board in practice. If I had the power to influence policy, I would leave things the same and try not to mess it up. There’s a reactive aspect of policy-making where you mess things up even further in response to something going wrong.

When I re-read your book, I was struck by how actively and efficiently many assets are being managed today. I’m shocked to say this, but it seems like an improvement.

I think it’s undeniably true that governance is better. When you engage with a multi-billion-dollar company, in general you have a high-quality board trying to do the right thing.  I do think we have come a long way since the 1950’s, the 1960’s and the 1970’s.

There recently have been changes to the proxy rules allowing for “universal proxy access”.  Does this change the risk/reward for you to get more active as an investor?

I’m involved in a company called The Joint (NASDAQ: JYNT), that I believe was the first company to have a hostile proxy access director elected. There are two aspects of the rule: 1) the ability of long-time shareholders to nominate a director, and 2) the inclusion of the director on the company proxy.

This should save activist investors a lot of money.

No one really knew what the institutional passive holders were going to do with these campaigns. Take ISS, who is very important, and whose whole mantra is that there must be a case for change. So, what do you do when you have a long-standing stockholder who has a very good candidate that they nominate?  Maybe that case for change is not there, but they’re using this tool that has been provided to them to add a qualified, good candidate.  No one knew how that was going to play out.

There was also this dynamic of super-aggressive, preemptive defensive moves by corporations. A lot of companies would put very onerous requirements into their bylaws if you were to use proxy access. For example, one company, Churchill Downs, the horse racing company, had a requirement that if you use proxy access then you must disclose all the investors in your fund. Very onerous stuff.

The jury has been out on whether proxy access was going to be good or bad. From our perspective, the early results have been that proxy access is good. It has improved engagement and, in some ways, lowered the bar for the standard for change, and people are using it. However, things can change. It’s extremely early days.

After Engine No. 1 with a 0.02% stake on Exxon won two board seats, I would have expected a lot more activism, and that never happened. What are your thoughts on why that never occurred?

The activism industry is fascinating right now.  It has become very specialized, and it is dominated by the same players. There are as many proxy fights as ever, historically we’re off the peak, but still at a very healthy level. The share of those fights being done by the same eight funds is pretty crazy. The ones that aren’t from those eight funds tend to be people who used to work at those eight funds. I think they showed the power of the ESG toolkit. In the end, being an effective activist requires a degree of specialization. Just because you can get two seats on a board doesn’t mean it is going to work out for you. It didn’t cause a floodgate to open because it still is a specialist game.

You’ve been a long-time holder of Star Gas (NYSE: SGU).  Would you talk about that position?

Star Gas has been a buy-and-hold forever for us. They distribute heating oil and some propane.  We’ve made our money through dividends and occasionally sold the stock when it gets to our price.  It’s still very valuable, we think it is a great asset.

Can you talk about the Joint Corp. (NASDAQ: JYNT)? You own 24% now.

Yes, the Joint was the winningest position in the history of our fund in terms of realized gains, which was very exciting when it happened. Then you look at the stock chart and it’s basically a flat line, a spike, and then it’s back to a flat line at the same level. So maybe we just got really lucky!

It is a franchising business for chiropractic clinics. The clinics have great unit economics, and the market got very excited about the growth prospects. They have both company-operated stores as well as franchises, and the deployment of capital between these areas has always been a hot topic for shareholders.

When we first got involved, everyone was mad that they were focusing on franchising and the shareholders wanted the company to deploy capital into the company-operated stores. Before we got involved it was the opposite, and they brought a franchise-focused CEO to repair the brand.  Fast forward to today, the company has moved into opening more of its own stores, and those clinics are underperforming. The franchises are doing ok. But all of this raises questions for shareholders about the company’s capital deployment, and the management really lost support from investors. Fortunately, when you buy up a large enough stake, you can have some input on these topics.

They have 800 or 900 units today, how big of a concept do you think it could be?

I really don’t know. They’ll tell you it can be 2,000 domestically. They might be right. There’s a huge overseas opportunity too. I can underwrite it to 1,500 units. When I first bought the stock, it was valued at about $80 million and I thought I could always underwrite a $300 million valuation for the business. After rocketing to a $1.2 billion valuation, The Joint’s valuation today is now back to around $125 million. They have a large net cash balance. Their franchising segment does about $35 million in revenues and $25 million in segment profit. It’s a healthily growing piece of the business, and I think it has good long-term growth prospects.

Do you think the company-owned stores are losing that much?

No, I’m backing out corporate overhead. The company-operated piece is about 135 clinics. They’re mature clinics but they haven’t done a great job of making the segment profitable. The segment profit from that piece was only about $5 million last year; it was $10 million the year before. One low-risk path is to refranchise those stores and drastically cut overhead costs.  You could buy back the stock with the proceeds of the sales if you wanted, and the business would continue to earn franchise royalties.

Q&A: What did you learn from your music career that helped in your investing career?

I played in a band in my youth. Being in a van with four people and touring is an incredible experience in training your disposition. I loved it. It was a great experience. It was a great way to see the country and the world. You learn a lot about yourself when you’re on tour. You learn how to deal with other people and how to deal with yourself, which is important.

Q&A: What screens do you use that you find are helpful in getting you candidates for your investment?

I don’t really use screens. As I’ve talked about before, I really focus on a quick filter to manage that idea funnel. On Yahoo! Finance, there used to be an industry browser that had lists of companies and I would go through that, sorted by market cap.  I’ve never found that limiting the universe at the screening phase did me that many favors.

Perfect. Thank you and good luck!

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Favorite Books & Media

Lex Fridman: Jeff Bezos: Amazon and Blue Origin

Simply, an amazing podcast with a focus on Blue Origin and space travel, along with some other timeless wisdom mixed in.  Bezos is so brilliant and articulate, and he shines in this long-form format that allows him to show his full intellectual muscle.  Also, his laugh and positive attitude are infectious.

https://podcasts.apple.com/tw/podcast/405-jeff-bezos-amazon-and-blue-origin/id1434243584?i=1000638603427

Rick Rubin Interviews Marc Andreessen

Rick Rubin, the music producer and host of the Tetragrammaton Podcast, interviews entrepreneur and investor, Marc Andreesen.  Andreesen is an encyclopedia of knowledge (sometimes too much!) on a range of topics, including on topics such as venture capital, characteristics of successful startup founders, artificial intelligence, politics, and more. While not super technical, this interview covers a lot of ground and digs into a lot of deep topics from a layman’s perspective.

https://podcasts.apple.com/us/podcast/marc-andreessen/id1671669052?i=1000640405874

Capital Allocators: Dmitry Balyasny on Multi-Strategy Platforms

Multi-strategy investment platforms have become the dominant asset class in recent years, and Balyasny is one of the leaders.  I thought this interview was super interesting, providing insights into how multi-strategy funds think about managing portfolio allocation, exposures, risk, and talent.  Given that multi-strats are often the “tail” that is wagging the market dog these days, it is valuable to understand how they are thinking and managing their assets.  Additionally, Balyasny gave me a few new ways to think about portfolio management and construction.      

https://podcasts.apple.com/us/podcast/capital-allocators/id1223764016?i=1000639897460

Growth Investor with RJ Lumba: Leading Franchisor Investor Princeton Equity Group’s Jim Waskovich

Fresh off of our recent interview with Jim Waskovich of Princeton Equity Group https://ragingcapitalventures.com/interview-with-james-waskovich-private-equity-investing-in-franchisors-and-multi-unit-businesses/), RJ Lumba recently shared this podcast with Jim which covers some additional details about his business and investment approach.

https://podcasts.apple.com/us/podcast/growth-investor-with-growthcap-s-rj-lumba/id1310560053?i=1000641161219

 

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A Selection of Recent Tweets from @RagingVentures:

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Fortuna Audaces Iuvat – Fortune Favors the Bold!

 

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