Following the founders
This manager finds value in founder-run companies
The word “value” has many connotations for investors. Some define it statistically: as a stock with a low price-to-book ratio, or a low price-to-earnings multiple. But the portfolio management team at Vancouver-based PenderFund Capital Management has a different approach.
They think about value in the context of getting more intrinsic value out of an investment than is being paid to acquire it.
“Nobody knows what the future holds, so you have to have some kind of sensible estimate of what the future holds for the company, which often includes some kind of estimate for growth,” said Felix Narhi, PenderFund’s chief investment officer. “Then you want to pay a price that’s fair to less than intrinsic value, otherwise you don’t beat the market.”
Narhi is portfolio manager of the Pender U.S. All Cap Equity Fund and the Pender Strategic Growth and Income Fund, as well as comanager of the flagship Pender Value Fund.
He highlighted Google parent Alphabet Inc. (GOOG/Nasdaq), a holding in the Strategic Growth and Income Fund, although the firm generally skews away from very large companies.
Most of the biggest names in the S&P 500 today are capital-light firms, such as Apple Inc., Microsoft Corp., Facebook Inc. and Google. Whereas 25 years ago, the opposite was true with Exxon Mobil Corp., General Electric Co. and AT&T Inc.
Narhi pointed out that today’s leaders don’t have to build big stores or plants like Wal-Mart Stores Inc. and GE did in the past. As a result, the most valuable companies these days have large amount of net cash, and no net debt.
“There is very little capital in these top corporations, yet they still make huge amounts of profits and free cash flow,” Narhi said. “The fundamental nature of business has changed dramatically over the past couple of decades, and I think that really has big implications for how we should invest.”
He believes value is not being created by building the next incremental store or adding a factory, but by doing things like piggybacking on the infrastructure that’s already in place.
“Google uses all the internet infrastructure that’s come from capital invested by cable companies and telcos, so they don’t have to spend a huge chunk of capital,” Narhi said.
Stemming from PenderFund’s historical preference for a private equity and venture capital-like approach to investing, the firm’s portfolios are also often dominated by founder-run companies.
Narhi cited a Bain & Co. study showing that founder-run companies in the S&P 500 generated three times more wealth between 1990 and 2014 than those run by professional executives did.
“Obviously there is something going on with the market systematically undervaluing founder-run companies,” Narhi said, noting that the ideal time to buy these stocks, is where there has been some sort of accident or mistake.
Two years ago, PenderFund bought Wynn Resorts Ltd. (WYNN/Nasdaq), which is run by Steve Wynn, one of the most successful value creators in the U.S. The stock has almost tripled in value since the investment, which occurred after the Chinese government’s corruption crackdown spooked investors about Macau’s future as a popular gambling destination.
“People thought the Chinese would never come back and gamble again,” Narhi said. “Turns out, they were wrong.”
Panera Bread and Whole Foods were other fund holdings, which have since been taken over, but also ran into some difficulties.
“They weren’t necessarily problems, but sometimes companies need to reinvest their business models,” Narhi said. “Investors tend to be too impatient to see these things through.”
The firm prefers names like this that are outside major equity indexes, although Baidu Inc. (BIDU/Nasdaq), the top holding in the Value Fund, isn’t absent from the S&P 500 because of its size. The Chinese internet giant has a US$85 billion market cap, but isn’t included in the index because it is not headquartered in the U.S.
Narhi noted that Baidu has taken a page out of Google’s playbook by using cash from its core search engine business to fund other initiatives, although there have been mixed results for some.
The company has a 20 per cent stake in CTrip, which has a near monopoly position in the online travel market in China, but it’s Apollo autonomous driving program is perhaps its most interesting venture.
Narhi noted that while many competitors are taking a guarded approach to intellectual property, Baidu is almost adopting the opposite strategy by essentially providing all their IP for free to get more partners. That should allow them to collect more data and information, and make the system more robust, a path that worked out well for Alphabet.
“Nobody really directly monetized the mobile platform like Apple did, but when you take a look at Android, it’s been quite helpful for Google in the long term,” Narhi said. “Initially, you have to create the critical mass and get the network effect going.”