Speaker unverified: evaluation

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…ttractive shorts are the ones where it's like cyclically, they're just overearning a lot. And you believe that the real earnings, if you were to look through a cycle, are much lower than people think. And how do you think about—so there's a company, maybe they're in a bad place and it just doesn't seem like it'll work out, but there's always this fear that they get bought out or that there's a sudden management change. Do you just size your books such that that's okay for you, or do you use options? I find that, generally, companies that have secular risks almost never get bought. Rarely do I ever see a CEO say, “I want to go buy something that grows slower than I do.” Right? This doesn't happen. Nobody wants to take the time to do an acquisition that's going to invite a bunch of secular risks into their business. Maybe Ron Perelman did that back in the day, but that doesn't happen. What can happen is if you have a company, the example I gave where there's a company in the industry that you just believe is going to cede market share for a long period of time because of their positioning or management or strategy. And then what can happen is an activist comes in, picks a big stake in the company and says, “We're going to replace the management team. And once we do that, the new management team will pursue a different strategy and they will no longer lose market share.” That is a big risk in that category. That's kind of the only category where— And to manage that risk, you just manage your book. Do you use derivatives at all? I really don't use derivatives at all. The problem with derivatives is, look, at the end of the day when you break down what is a derivative, it's just leverage and implied volatility. If I want leverage, I can go get leverage from a prime broker. I don't have any view on implied volatility. And the problem with derivatives is there's typically a timeframe and I'm not good at timeframes. I don't know when a stock is going to work or—that's very difficult. So I don't like having something that’s making a bet that something's going to happen at a certain period of time. We keep it pretty simple and just trade underlying stocks. So I think that nobody buys businesses to grow slower than them, or rarely. People usually don't buy companies that are market share donors. With CEOs, I really want to buy this. That's like a headache, right? So there's a stage of the life cycle where companies kind of become un-acquirable? on't buy companies that are market share donors. With CEOs, I really want to buy this. That's like a headache, right? So there's a stage of the life cycle where companies kind of become un-acquirable? Those companies, I don't worry about them being acquired. What you worry about, as I said, an activist comes in, replaces management. Usually the new management team can't fix it, but sometimes they can. And that's a risk. In terms of the companies where I said they have no terminal value, the risk is just that they usually trade at low multiples. And so you're basically just DCF-ing the cash flows. And if the cash flows—if something happens and people receive the cash flow, it’s going to last a little bit longer because the starting valuation's low, they can go up. Cyclical shorts are just entirely different. The risk is just that you're early or you're just wrong about the cycle. There's something about the cycle, which is different this time, but those are kind of the main categories of shorts. Speaking of cyclicals, why has Rolls done so well? They’re up 5x, 10x over the last few years. This is Rolls-Royce, the jet engine and turbine manufacturer. Yeah, yeah. Their main business is aircraft engines for wide-body jets. They're not big in AI, IGTs? Not as far as I know. They have an SMR business, so that could eventually help. Rolls is not very cyclical. The reason why— Aren't engine makers historically cyclical? Not as much as you would think, because most of the business is: I sell you an engine for not much money, but I make a lot of money in aftermarket, which is much more predictable. So the airframers are cyclical, but the engine makers aren’t? Airframers are cyclical, but pretty good secular growth and it's a duopoly. Rolls-Royce was just horribly bandaged for a long time. Making jet engines is incredibly difficult. It sounds hard. It probably takes like five to 10 years to do the R&D to develop a new jet engine. So Rolls-Royce actually had good technology. It was just very, very poorly managed and they signed a bunch of contracts with airlines that were very unfavorable. And they had a new CEO come in and he operationally turned the business around in a pretty fantastic way. You guys were long Rolls, right? Yes. So that's a good example of how—because every management team says, “We're going to turn this thing around.” And every management team has a projection that looks good. And so how did you determine that now finally they're going to turn it around? anagement team says, “We're going to turn this thing around.” And every management team has a projection that looks good. And so how did you determine that now finally they're going to turn it around? Okay, so let me start by saying the US and Europe are very different in this respect. Let's take a US company that had a turnaround industrial company like 3M. 3M had been a horrible stock for a very long time. Wasn’t well managed, new CEO comes in, puts up one or two good quarters—we owned it. Everybody basically understands what's happening and the stock kind of goes to fair value with the assumption that the margins are going to go where they should go. The US is pretty quick at seeing change happening and then pricing in that change. In Europe, I find… A company like Rolls had underperformed for so long, I guess that European mutual funds, they just kind of got in their head that Rolls-Royce is something we just don't want to touch. So the voting machine is laggier in Europe? Why is the information connectivity higher than in the US? What's going on? I think it's hard for me to explain, but I've seen it over and over again in Europe. It's almost like when Rolls was being turned around, it was pretty clear after the first year that what he was doing was going to work. And it wasn't really that difficult to— Based on earnings, based on deliveries, based on talk to customers? Based on—you meet with the management team. They say, “Here's our plan, here's what we're going to do.” You see things playing out. You see the income saving progressing as the person said. You get a sense for Tufan—name of the CEO. You get a sense for like, okay, is this person good the same way you would assess it. Is the right framework that it's US and rest of world? Or is Europe uniquely bad at this compared to Latin America, compared to Asia? I don't do enough in Latin America to have a strong view. But a Japanese turnaround, would that— I think Japanese turnaround would be closer to Europe than the US, but I've done a lot more in turnarounds in Europe. If Rolls-Royce was trading in the US, I'm fairly confident that after the first few quarters and people meeting the CEO, it was very clear to me that the CEO was excellent. And why is that functionally, do hedge fund managers, or most of them presumably, are in the US and they mostly like to buy American stocks or— I think the American markets are just much more efficient. There's just a lot more capital. But there are no hedge funds—very few hedge funds presumably—only invest in the US. I think you'd be surprised. I mean, I think Europe is generally viewed, appropriately so, as an extremely low-GDP, unexciting place— There's an issue where presenting that to your LPs is kind of embarrassing. Is that part of the problem? Like, “Oh, we took a position in a European company. I'm not sure we would want to do that.” No, no, no. Obviously you don't. But I'm just trying to understand why the average hedge fund manager doesn't just back up into Rolls. But isn't it just a home country bias? People invest in what they know.…

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