A few years ago, Distressed Debt Investing interviewed the team from Aegis Financial as part of our Emerging Manager Series. In mid 2012, I spoke with Evan Vanderveer and David Shapiro who let me know they had raised capital for a new fund. Not only that, but the backing comes from one of the best value investors out there: Tom Gayner on behalf of Markel - a firm people often describe as a mini, and possible the next Berkshire Hathaway. That in itself is a massive ringing endorsement and I think, as the interview below will testify, will demonstrate the skill of this emerging manager team. For more information, you can find their website here: http://vanshapcapital.com/ Enjoy!
1. Give us a background on Vanshap Capital. How did the firm come to be? Describe the firm’s approach to investing.
We were previously members of the investment team at Aegis Financial, a highly regarded deep value manager also here in Arlington. We had both been drawn to Aegis because of our interest in—and the firm’s strict adherence to—investing in mostly smaller, undervalued companies. Over the period that we worked side by side, we both began to recognize that some foreign markets were priced less efficiently than the domestic markets we were primarily analyzing at the time. Our interest in global deep value equities evolved into the idea of building a firm solely focused on that strategy.
After pondering how best to raise capital, we decided to reach out to a handful of other value oriented institutions that could be in a position to assist with forming a new firm. The idea was to find someone who really appreciated our strategy and took a truly long-term view. One of the value investors we contacted was Tom Gayner of Markel Corporation. After a series of discussions with Tom and other potential investors, we concluded that partnering with Markel would be a terrific fit, and that has indeed been the case.
Our investment approach is fairly straightforward. The description is “focused global deep value investing.” We own stakes in 15 to 30 public companies located around the world. These companies broadly have low levels of debt, generate high returns on capital, and have strong management teams at the helm. Most importantly, they trade at low multiples of tangible book value or cash earnings. The philosophy is driven by the fundamental belief that a carefully selected portfolio of financially sound, well-run companies selling at discounted valuations should generate above average returns over time.
2. In the current market environment, where are you seeing the most opportunities?
We are seeing opportunities where we typically find them—in smaller, orphaned, out-of-favor securities. In many developed markets, companies with market caps of less than $250 million have very little or no analyst coverage. Specifically, last year, we found the U.K. to be fertile hunting ground. Many of the brokerage firms there have dropped coverage of small caps during or in the few years after the crash. One of our holdings, Dart Group, had a market cap of just £20 million in mid-2008. Today, the market cap is £220 million, but fewer analysts cover the company now than did back then; another well-known broker just dropped coverage. Dart is far from a one off example; we see the same phenomenon time and again when scouring the globe.
We are fond of the John Templeton quote “People are always asking me where the outlook is good, but that is the wrong question. The right question is: Where is the outlook most miserable?” Not coincidentally, we find many of our investments in countries, industries, or specific businesses that are experiencing some kind of ‘misery.’ Often the confluence of small size, lack of attention, and misery create the investment opportunities we find attractive.
3. What influences have most shaped your investment philosophy?
Our driving influence is the overwhelming amount of data that supports the effectiveness of a small cap deep value strategy. According to our analysis derived from the Kenneth French data set, equities in the cheapest decile of the market on a price-to-book and price-to-earnings basis outperformed the most expensive decile by 14% and 10% annually since 1952. Many other studies draw similar conclusions. The data also matches our personalities; we enjoy searching for bargains and are inherently contrarian by nature.
The other influence, on a more personal level, is Scott Barbee, who is the owner and portfolio manager at Aegis Financial, our prior firm. As we mentioned, Scott was our deep value investing mentor, and is similarly driven by data that suggests buying stocks trading at a discount to tangible book value outperform the market over time. Scott is one of the more disciplined investors we know; he refuses to wander from his time-tested strategy no matter what is in vogue. He is highly skeptical of consensus opinion and searches for investments in the most out-of-favor areas of the market. We are forever indebted to Scott for providing a strong foundation to our investment philosophy.
4. What advantages, if any, does your background in high yield investing give you in the world of small-cap value equity?
We would argue our background in high yield investing has provided two advantages. First, we believe debt investors tend to be more focused on the downside scenario or the “margin of safety,” and are inherently less optimistic about potential outcomes. Relatedly, we have trained to closely examine the asset backing of the business and what might be left over if something did go wrong. The second advantage would be strong analytical experience when studying debt structures, covenants, and other more technical aspects of the balance sheet. We believe these skills are important even when investing in relatively unlevered companies to ensure there are no peculiarities when performing due diligence.
5. Coming up on one year since Vanshap was founded, what has been the most difficult aspect of starting your own firm? What advice would you give to others who may be considering taking the leap?
As an analyst, the focus is simply on the investment side of the business. When you launch a firm, there is an entire other role that develops; actually managing the organization. This hasn’t been so much difficult as it has been a change from our previous roles. Thankfully, we really enjoy both aspects. We have purposely structured the business to have as many functions outsourced as possible so we can concentrate on investments and the broader strategy of the firm, while keeping a close eye on our service providers.
Our advice would be to find a high-quality partner, an organization or person that you admire, and build the firm with their support. In today’s environment, we would argue that scale and a proper back office is required to sustain the business over the long term and attract capital from institutions. This is not to say one cannot go at it alone, but we think the partnership route is the more conservative and potentially rewarding model.
6. What type of personality does it take for a person to be comfortable with your investment style?
To answer the question in one word: contrarian. Individuals who want large exposure to the hot stock of the day—the one everyone is suggesting should be bought—will be disappointed with our style. We invest in companies that people are selling or that no one is discussing.
We seek to attract individuals who understand our fidelity to deep value investing, have a long-term focus, and are more prone to add capital in a declining rather than a rising market. As Seth Klarman has discussed, you can have everyone in the country attend the Berkshire Hathaway Annual Shareholders Meeting and only a small percentage of attendees will become ‘value investors.’ We fit best with the few who do.
7. Why do you believe deep-value equities represent a better opportunity relative to other asset classes going forward?
We don’t frankly know if deep-value equities will outperform other asset classes, but we do believe the strategy will outperform other equity strategies over the long term. As mentioned before, we believe the data supports this view. That being said, we think predicting the performance of individual asset classes is a tough game and that reversion to the mean plays a large role. Instead we believe that owning a stake in a handful of undervalued, high-quality, well-managed businesses will produce acceptable returns over time regardless of how other asset classes perform.
8. Vanshap invests in deep value equities on a global scale. Which countries do you find most attractive from a valuation standpoint?
Our answer to the question is driven by what countries appear on our worldwide screens, and those countries are often undergoing some kind of misery. To give you a sense, we have a few investments in Australia, which is currently experiencing a sour economic climate and some industries there are being impacted by “Dutch disease.” We have one investment in South Africa where there are major labor problems and a stagnate consumer environment. Although U.K. small caps have appreciated recently, we believe the austerity and negative sentiment there is creating opportunity. Additionally, we have been looking in the troubled Eurozone countries, including Greece where we have an investment in a large retailer. There are many Korean, Hong Kong, and Japan-based companies on the list. We have looked closely there, but frequently have trouble with the corporate governance.
9. What is your approach to understanding geopolitical risk? Can you describe a specific situation where you have passed on a compelling idea because you couldn’t get comfortable with the geopolitical risks?
When analyzing a potential investment, we pay particular attention to what risks from the political sphere could damage our investment thesis. Have there been recent government seizures of personal property, or is there a strong rule of law in this regard? We ask management about political risk, and they tend to be quite candid when discussing the topic. We additionally search widely in the media for any indication of positive or negative change in the country’s rule of law. However, we believe predicting a political event is just as tough as predicting stock market performance, so we tend to have investments in a variety of countries and regions across the world in case an event does occur.
We looked briefly at a company based in a fast-growing Southeast Asian country. The company makes a lubricant product and has a roughly 63% market share because of a near-monopoly position protected by government tariffs. The business was exceptionally well run and arguably undervalued at the time. However, the company admitted that if the rules governing the industry were changed and foreign competitors were allowed to enter, the profitability of the business would be severely impacted. While there was no real threat at the time, we were concerned that trade protectionism could change at some point, so we decided to pass. The stock has performed quite well and there may well be no shift in the industry.
Conversely, political events can create opportunity and cause stocks to become highly discounted. We have a stake in a Canadian energy company that owns a large acreage position in a prospective shale gas play in Quebec. The government there placed a moratorium on fracking for a few years and the stock has declined by 80% from the highs. Interestingly, we think the company’s other assets are worth significantly more than the enterprise value today, even if fracking in Quebec is permanently banned. So in this case, the political event created the opportunity.
10. What is Vanshap’s approach to hedging macroeconomic risk?
We don’t hedge economic risk in the normal sense of the term with exotic derivatives or anything along those lines. Instead, we attempt to ‘hedge’ by owning a basket of undervalued, high-quality companies from around the world that operate in a variety of industries. Our thinking is “invest from the bottom up, but worry from the top down,” so we try to consider what could go wrong on the macroeconomic front. For instance, how would a Chinese crash impact our investments? We are constantly considering questions like this to try and ensure no one event could unduly harm the portfolio.
11. Tell us about your favorite investment idea.
Our largest investment is the company we mentioned previously, Dart Group. Though the stock has appreciated recently, the business still appears to be materially undervalued. Dart is a U.K. based holding company with three different businesses, although two are intertwined and one is wholly unrelated. Jet2.com is a leisure airline and Jet2 Holidays is a packaged tour business that utilizes the airline. The other subsidiary is Fowler Welch Coolchain, a distribution business that works with many of the large supermarket chains, including Tesco.
Philip Meeson, the Chairman and CEO who owns about 40% of the group, has done a fantastic job since joining in 1983. Over the last decade, he has compounded tangible book value at 19% annually, a remarkable achievement in our view. The record over the entire period is not much different. The business is run extremely efficiently, with a non-unionized workforce and a flexible, largely owned aircraft fleet.
Dart is currently valued at roughly 7x earnings, or 6x earnings net of excess cash, and just slightly over tangible book value. Another way of looking at the valuation is to subtract the value of the distribution business, £50 million which we think is conservative, and excess cash of £40 million. That implies a value of less than 3x EBIT for the airline and holidays businesses, while comparable tour businesses also with internal airlines, Thomas Cook and TUI trade at 6x EBIT. The company reported first-half profit before tax grew 37% over the prior year and the packaged holidays business, Jet2 Holidays, has yet to reach even half of management’s market share goal. We think the group’s brightest days are ahead.
