In the year before Berkshire bought it (at the end of 1996) for $1.5bn FlightSafety International produced $111m in pre-tax earnings. Buffett was right in thinking that its strong market position would lead to a significant rise in profits. By 2007 pre-tax earnings were $270m. At this time the company could have been sold on to someone else at much more than Berkshire paid.
But Buffett had made a solemn commitment to Ueltschi and his staff that Berkshire would never sell. Also, a sale wouldn’t make sense when the economic franchise was even stronger in 2007 than it was in 1996, and the managers even better. Pre-tax profits over the first thirteen years of ownership amounted to about $2.5bn. By 2009 annual profits were over $300m and rising. Berkshire gained another $3.5bn or so of pre-tax profits over the next decade. Even after tax is deducted that is over 150% of what was paid for the company in that decade alone. And still Berkshire gets to own it, receiving, year-in-year out, the hundreds of millions of dollars of cash it generates. Operational management In terms of managing the business, Ueltschi said that nothing changed after 1996, and that is just the way he wanted it. He said “Warren Buffett…he’s not the type of guy that would try to break something up. Some of these big companies, they buy the company then there is big stuff they want to change: they put their name on it, they want to change everything. All the people that worked there for years, that built this thing up – and they’re in there because it’s their life’s blood and they believe it – they lose all their enthusiasm because there’s somebody from the big office comes in and tells them how to run it. And these people know how to run it. I’ve got some of the finest people in the world working at FlightSafety and they all are dedicated, they’re loyal, respectful and they’re honest and the do everything to take care of the customer.” (Al Ueltschi in an interview with Robert P. Miles (2002) The Warren Buffett CEO) Buffett once asked a group of Columbia University students, “do you think Al Ueltschi, who owns $1 billion in Berkshire stock, is going to want to keep running his business if I’m over his shoulder making decisions?” There were other benefits for Ueltschi in being part of the Berkshire fold, including avoiding Wall Street analysts constantly asking how much money FlightSafety was were going to make next quarter and why it didn’t make more last quarter. “Now we run the company for the long term without worrying about the next quarter. That’s one of the best things about working with Warren.” Ueltschi pointed to Buffett’s amazing leadership ability, saying the letters of the word represent the qualities he possesses: L is for loyalty E for enthusiasm ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
0 Comments
First: A tip to simplify portfolio construction to manageable proportions – favour low-change industries
Buffett and Munger made life simpler for themselves by investing in businesses and industries unlikely to experience major change. “The reason for that is simple: we are searching for operations that we believe are virtually certain to possess enormous competitive strength ten or twenty years from now. A fast-changing industry environment may offer the chance for huge wins, but it precludes the certainty we seek.” (Warren Buffett’s Letter to Berkshire Hathaway shareholders 1996) This advice does not mean searching out areas where there will be no change at all. That wouldn’t work because all businesses are subject to some change. But it does mean looking for areas where the fundamental economics (pricing power relationships) are unlikely to alter. Buffett highlights the example of See’s Candy where change has clearly come. The range of candy has changed, as has the machinery used in production and some of the methods of distribution. But people today buy See’s candy for the same reasons they did in 1972 when the company was bought by Berkshire and these reasons are not likely to change over the next 50 years (in California there is long established devotion to See’s Candy – no Californian would want to give their girlfriend, wife or mother a lower quality candy). Another example: Coca-Cola. It is continually looking to improve the way it carries out its operations to gain efficiencies. New technology will help, new advertising methods on the internet will help. But…… ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 In the context of recently paying $1.5bn for FlightSafety, Warren Buffett, in his 1996 letter to shareholders, emphasized that intelligent investing is not complex. Flightsafety’s technology might be complex but the evaluation of the business is relatively straightforward. It was the dominant supplier of flight training outside of government and major airlines. It had the best trainers and an excellent team of managers. It had a deep moat that is dangerous for potential rivals to try and cross because it has the reputation, the technical knowhow and the facilities, a combination hard to replicate.
While intelligent investing is not complex it is far from easy. Not everyone has the focus, inclination or the business knowledge to be able evaluate matters such as strategic positioning, and competence and integrity of leaders. Many would rather focus on squiggles on a chart, guess the mood of the stock market or get a feel for the next big thing (is it lithium or online payment firms or bitcoin this month?) than look at businesses. To invest successfully you don’t need beta, option pricing theory, or modern portfolio theory (And I authored the best selling corporate finance textbook on this stuff! - but, after explaining the theory, I do take a sceptical line about practical application as well as theoretical problems). Buffett tells us that “what an investor needs is the ability to correctly evaluate selected businesses.” The word “selected” is very important. You cannot be an expert on every company, or even many businesses. But that doesn’t stop you from being an intelligent investor. “You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.” You need to learn two things:………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 How Warren Buffett makes a deal to buy a company - the example of FlightSafety International26/11/2020 Many large companies approached the founder and 37% shareholder of FlightSafety, Al Ueltschi, in the 1990s to ask whether he would consider selling the company. After all, he was already well into his seventies and needed to think about what might happen upon his death, e.g. tax would have to be paid from his estate.
He could not bring himself to sell his creation, with its cadre of first-class trainers and technologists, many of whom were dear friends, to one of Wall Street corporate raiders. They might leverage it up, bring in their own inexperienced and clumsy managers, and/or sell it off piecemeal. He said “I’ve seen big companies when they buy little companies; they’ll try to change everything. And I didn’t want to do that. A lot of our workforce had been there for years, and I wanted to see that it could carry its mission of making aviation as safe as we can. These are good people.” Ueltschi had not met Buffett despite him sending his pilots for training at FlightSafety (Berkshire had bought an airplane for Buffett to move around the country, which he named "The Indefensible”). In fact, the idea for a merger didn’t come from either of them. Buffett’s “heroes” of this story are Richard Sercer and his wife, Alma Murphy. Sercer was familiar with aviation and the market commanding position of FlightSafety because he was an aviation consultant. He was also a shareholder in the company. Murphy, an ophthalmology Harvard Medical School graduate finally, in 1990, wore down her husband’s reluctance to buy Berkshire Hathaway shares (they had seemed expensive to him in the 1980s). Thereafter they attended every Annual General Meeting and so knew Buffett’s criteria for acquisition. They judged FlightSafety would make a perfect fit. They also thought that Ueltschi would welcome a deal because it would give a good home for his business without disturbing the business model or the leadership. Making a pitch Sercer had long had a good working relationship with FlightSafety’s Vice President of Marketing, Jim Waugh, built on his work for corporate aviation clients. On July 24, 1996 the two met. Sercer took along Buffett’s “Owner Manual”, an updated version of which had been given to Berkshire shareholders the previous month (the original was written at the time of the Blue Chip merger in 1983). In this document (available at https://www.berkshirehathaway.com/ownman.pdf) Buffett sets out the thirteen principles by which Berkshire Hathaway will be managed such as, “our attitude is partnership…we eat our own cooking…[aim] to maximize Berkshire’s average annual rate of gain in intrinsic business value on a per-share basis…use debt sparingly”. He also gave Waugh copies of Berkshire’s acquisition criteria which include some very attractive stances for managers who might be interested in selling a business, such as, “Management in pla ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 Today I'll continue the story of how a strong economic franchise business was created from virtually nothing. It became so strong that Warren Buffett paid $1.5bn for it (I'll describe the making of that deal in tomorrow's newsletter)
In the late 1940s a number of companies bought corporate airplanes to provide greater flexibility and save the time of their executives. Ueltschi knew most of the pilots working for the directors because they would frequently meet at airports all over the country. He noticed that some needed to update their flying skills. The training at Pan Am, where Ueltschi worked as personal pilot to the founder Juan Trippe, was rigorous and never-ending, with pilots forever going back to the school to learn the latest system or navigation technique, or simply to refresh old knowledge. The head of operations was stickler for precision and professionalism. As Ueltschi recalls it,“we were tested to be sure we knew what we thought we knew. All of us understood that was what it took to be safe.” Ueltschi was often assigned to help out older pilots with the transition to DC-6s and Constellations. In contrast, corporate pilots had generally ceased training years before, many after leaving the military. The lack of up to date knowledge was a problem because new high-performance aircraft were coming into the corporate fleets. These were much faster than slow and low flying boats and other light aircraft they were used to. While major airlines were forced to keep up, through both internal pressure to be safe and government six-monthly proficiency tests, business aviation pilots were out on their own with no requirements to demonstrate competence. Ueltschi thought about the problem for a long time, eventually concluding that there might be an opportunity to establish a business serving their needs, offering a training system as good as the ones provided at the major airlines. He went to Trippe with the idea who thought it excellent; it would improve aviation and it was a good business opportunity. Ueltschi also talked to Bernard Baruch, a leading financier, advisor to Presidents and a friend, who was much more cautious, "You'd better be careful. You've got a good job at Pan Am, and you might lose everything." Ueltschi had to solve the problem of combining family security – by then he and his wife, Eileen, had four small children – and at the same time, follow his dream, His solution was to, first, take a $15,000 mortgage on their house and rent a 200 sqft office on the third floor of LaGuardia Airport for the new company, FlightSafety, in 1951. It had one paid employee, a secretary, who was to mostly type letters soliciting business. Ueltschi himself would be unpaid by the company (for 17 years). Second, he would hold onto to his job at Pan Am. Trippe was okay with that, so long as he restricted his FlightSafety business to his off hours and days off. For years there was little business because the older pilots generally couldn’t see the need for training. According to Ueltschi the typical attitude was “They already knew how to fly just fine, thank you, so why did they need advice from a bunch of outsiders?” Trippe was Ueltschi’s greatest supporter, and he convinced many of his pals at the top of Fortune 500 companies that they really need to be flown around by pilots fully conversant with modern airplanes. “We hung in there, and one by one the customers came a ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 The story I'm going to tell over the next few days shows how a talented manager can create a business with a deep and dangerous moat given enough time and dedication, even in an industry dependent on the notorious unprofitable airlines. There are many lessons for today's value investors.
Al Ueltschi fell out of an aeroplane in 1940 when he was 23 years old. One moment he was sitting comfortably, the next “the whole airplane was missing!” he says. The seat, with him strapped to it, had simply detached when the biplane was upside down. He was no longer an instructor pilot, “but rather a falling object heading straight for a patch of Ohio farmland”. It was very cold, but he knew he had to rip off his gloves to pull the rip chord on his parachute. The chute exploded through his legs, “so I guess I was upside down”. With only 150 feet to go the canopy finally opened. The episode was so jarring that the leg straps ripped his underwear. He landed in a briar patch, tearing more of his clothes. “Apart from some minor scratches and a severely bruised ego, I was fine”, he says. But the lesson in the importance of having a well-trained pilot who you could trust in all circumstances was truly learned. He had put his life in the hands of someone under his instruction. The student was trying a half snap roll. He kept failing and stalling the aircraft. The last attempt was so abrupt that Ueltschi’s seat simply fell out of the biplane. In those days, most training took place in the air, rather than in simulators, which resulted in more deaths by accidents in training than in normal flying. It was the same Al Ueltschi (pronounced Yule-chee) who 56 years later sold his pilot training business to Berkshire Hathaway for $1.5bn. He swapped his 37% holding for around $555m worth of Berkshire shares. The aviator who had flown solo at 16, continued to be in charge of the company until his death in 2012, aged 95, by which time his shares were worth $2bn. Much of that money has been used to provide millions of people in the developing world with sight-saving operations through the charity he established, Orbis. Today, FlightSafety International dominates the pilot training industry. Lindbergh and the love of flying Ueltschi was the youngest of seven born on a Kentucky farm in 1917. As he grew, he observed how his parents work all day, seven days a week for a meagre profit at the end of the year. He didn’t want to be a farmer. The ten-year old Alfred was enthralled when Charles Lindbergh flew the Atlantic. His ear was glued to the family vacuum-tube RCA radio, “listening for every scratchy- sounding news report on the progress of his flight. When the bulletin came announcing that he had landed in Paris and was carried off the field on the shoulders of thousands of cheering Frenchmen, I was hooked.” From then on there was no doubt in his mind, he was to be a pilot. (Running ahead of the story: Ueltschi and Lindbergh became friends and 35 years after the biplane mishap they ended up sharing a room at Le Bourget, the place in Paris where Lindbergh had landed all those years before. The pair were in France to evaluate an airplane). The young Alfred quickly recognised that farming would………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 The business model of Capital and Counties Properties, Capco (LSE:CAPC) used to be much more adventurous, with stakes in various projects around London. Now it has a 50% share in a relatively small development, Lillie Square, which is getting smaller as apartments are sold. This only accounts for 6% of its assets, leaving 94% of its holdings in or around Covent Garden.
It is focused primarily on renting out hundreds of units. It has become so much more a property holding company rather than a speculative property developer (although it does develop some of the properties when the opportunity arises) that last year it converted itself into a Real Estate Investment Trust. As such “the Group will focus on growing rental income and achieving operating efficiencies to develop dividend distributions in line with underlying earnings” In return for some restrictions a REIT structure lowers tax (the company does not pay tax on rents received or on capital gains – but shareholders will pay tax on dividends based on those rents). One requirement of REITs is to distribute at least 90% of net rental income to shareholders (shareholders may be subject to a 20% withholding tax). Other restrictions include that no one property accounts for more than 40% of total value (no problem for Capco) and interest cover (ratio of profits to finance costs) must be at least 1.25. Obviously, the loss of rent in 2020 means this last condition has been broken. But there is a get-out clause: HMRC may waive the condition in “severe financial difficulties due to unexpected circumstances” – I think Covid-19 counts. So, the idea of a REIT is to pump rental income to shareholders in the form of dividends. One issue that bothers me with Capco is that it reports net rental income of £57m - £75m but, in the past, has let its costs (including fat directors remuneration) mount up to more than that, thus reporting small operating profits or losses. Administrative expenses are £34 – £56m each year on top of net finance costs of £5 - £27m. As well as operating losses, it seems to regularly lose out on property revaluations and sales. Profit and Loss Accounts £m H1 2020 2019 2018 2017 2016 2015 Net rental income 18 61 57 67 82 75 Other income 0.3 2 3 4 5 4 Gain/loss from revaluations and sales -438 -43 39 -90 -229 +457 Impairment of other receivables 0 -21 -19 -1 -15 -12 Administration expenses -17 -43 -34 -39 -56 -52 Net finance cost -5 -14 -5 -3 -27 -11 Share of loss from JVs 0 -3 0 0 0.3 0.7 Tax -1 -1 -4 -7 +17 -3 Loss/profit from continuing operations -441 -62 37 -69 -224 457 Profit/Loss from discontinued operations 0 -246 -161 +6 0 0 Loss for the year -441 -308 -124 -63 -224 457 Share of loss to Capco SHs -441 -254 -57 -0.4 -119 431 Share of loss to minority interests 0 -54 -67 -63 -105 26These numbers do not shine a glowing light on the directors in charge of this company – no wonder the share price fell. Net asset value per share has fallen from £3.40 in 2015 to £2.36 in June 2020. But about half of the losses were on the Earl’s Court adventure rather than made in the home territory of Covent Garden. The directors have an ambition to get “underlying a ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 Capital and Counties, Capco (LSE:CAPC), owner of Covent Garden, is selling at less than net current asset value, and therefore appears to be a bargain. However, Mr Market marked it down because he fears that so much rental income will be lost due to Covid-19 and property investors will demand higher yields that property values will decline significantly wiping out a lot of the balance sheet assets – an issue dealt with in my last newsletter. Mr Market also fears that the loss of cash inflows and profits will result in it being unable to manage its debt load.
Debt The table provides the key data on debt. Note that in 2020 debt rose as the company drew down some of its revolving credit facility. But this was not distressed borrowing. An asset was bought with the money: 26% of Shaftesbury, which owns 15.2 acres of West London including Carnaby Street and Chinatown. June 2020 Dec 2019 Dec 2018 Cash, £m 295 153 33 Loan notes -548 -546 -548 Bank loans -63 Finance lease obligations -10 -11 -6 Revolving credit facility maturing between 2024 and 2037 -449 nil nil Net debt -712 -404 -585 Undrawn committed facilities under the RCF, £m 255 715 802 LTV ratio (net debt to property value) 32% (Limit set by banks 40%) 16.3………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 Last week I paid 103.3p for shares in the owner of 81 buildings in and around Covent Garden, Capital and Counties Properties, or Capco, (LSE:CAPC). The latest set of accounts, for the half year to end June, declare a Net Asset Value per share of 241p – and that is after knocking 17% off the value of the 1.2m sq ft of lettable space the company owns in London’s West End in just the first six months of this year. So, at face value, the shares are selling at less than half price.
I have not taken things at face value though. Through the application of conservative safety margin principles I ended up lowering the value per share a long way from 241p, but still comfortably above the price I paid. Market capitalisation is 855m shares x 103p = £881m. The share price history shows that CapCo has been thoroughly rejected by Mr Market. It was 470p in 2015. After the Brexit vote it dropped to £3 due to fears over the vitally of London. Then the lacklustre London commercial property market as well as Capco’s loss of half the money it put into Earl’s Court pushed it down to £2.50. It picked up when Nick Candy showed an interest in bidding for the company in October 2019, to a market capitalisation of around £2.3bn, 270p per share. After he walked away the decline continued to around £2. Then Covid-19 struck, and London office workers no longer took lunch at one of its tenant’s restaurants and tourists didn’t turn up. The second lockdown has made the short-term outlook bleak and so Mr Market sold all the way down to 98p. I believe this to be a good net current asset value investment with its share price so far below my estimate of net current asset value that there is a substantial margin of safety. Net Current Asset Value, NCV Benjamin Graham taught that we calculate NCAV by totalling the current assets then deduct all the liabilities. We then deduct one-third of inventories and one-fifth of receivables. At the same time, we consider the vital qualitative elements of (1) business prospects, (2) managerial ability/integrity, and (3) business stability It is my belief that this approach suits most companies, but there are some that, because of the way their balance sheets are designed, allocate the vast majority of the core tradeable assets, especially property assets – their stock-in-trade if you will – to the non-current part of the balance sheet. In these cases, and where the assets have market values that can be estimated with a reasonable degree of accuracy, I believe we can add them to the conventional NCAV. This is what I’ve done for Capco. Net Current Asset Value £m June 2020 December 2019 December 2018 Receivables (current) 160 139 38 Cash 295 153 33 CURRENT ASSETS 455 292 71 Deduct all liabilities -1075 -622 -681 Deduct one-fifth receivables -32 -28 -8 Conventional NCAV -652 -358 -618 Add property (investment, development & trading) 2122 2546 3336 Add financial assets (shares in Shaftesbury) 340 0 0 Add 80% of long-term receivables 133 199 179 NCAV plus long-term marketable assets 1,943 2,387 2,897 Well over ninety percent of Capital and Counties Properties, Capco’s (LSE:CAPC) property is in or around Covent Garden. Only £178m is outside of it, so, for all intents and purposes, we need to focus on Covent Garden. (Market capitalisation when I bought on Friday was 855m shares x 103p = £881m. The vaccine has lifted the shares this week to 137p. So MCap is now £1.17bn.
Net Current Asset Value £m June 2020 December 2019 December 2018 Receivables (current) 160 139 38 Cash 295 153 33 CURRENT ASSETS 455 292 71 Deduct all liabilities -1075 -622 -681 Deduct one-fifth receivables -32 -28 -8 Conventional NCAV -652 -358 -618 Add property (investment, development & trading) 2122 2546 3336 Add financial assets (shares in Shaftesbury) 340 0 0 Add 80% of long-term receivables 133 199 179 NCAV plus long-term marketable assets 1,943 2,387 2,897Property (investment, development & trading) “The fair value of the Group’s investment, development and trading property at 30 June 2020 was determined by independent external valuers…based on the highest and best use…A valuer will consider, on a property by property basis, its actual and potential uses…A number of the Group’s properties have been valued on the basis of their development potential which differs from their existing use. In respect of development valuations, the valuer ordinarily considers the gross development value of the completed scheme based upon assumptions of capital values, rental values and yields of the properties which would be created through the implementation of the development. Deductions are then made for anticipated costs, including an allowance for developer’s profit before arriving at a valuation.” (Interim Report) While there is some degree of speculation concerning the valuation of development properties, and therefore cause for scepticism at a time of falling rents and property values, this need not worry us too much because most of the Covent Garden estate is already developed and in a steady state. The weighted average rent per square foot in Covent Garden is £82 per annum, but the range is wide (£17 - £281). After a 17% decrease in the valuation over the first six months of 2020 Covent Garden is valued in the 30th June accounts at £2,165 million. The main contributors to the devaluations are:
Here is the company’s sensitivity analysis around those guesses (Interims to 30th June 2020):
|
Glen ArnoldI'm a full-time investor running my portfolio. I invest other people's money into the same shares I hold under the Managed Portfolio Service at Henry Spain. Each of my client's individual accounts is invested in roughly the same proportions as my "Model Portfolio" for which we charge 1.2% + VAT per year. If you would like to join us contact Jackie.Tran@henryspain.co.uk investing is about making the right decisions, not many decisions.
Categories
All
Archives
May 2023
|