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  • MALE SPEAKER: Hello, and welcome everyone

  • to another episode of our Value investing Series.

  • We have a very special guest with us today.

  • So in thinking about introducing him,

  • I have to start off with a series of experiments,

  • a series of studies that were done

  • at Stanford by the professor Walter

  • Mischel in 1960s and '70s.

  • These are also most widely known as the Stanford Marshmallow

  • Experiment that you might have heard of.

  • Essentially, it was an experiment.

  • It was basically a bunch of studies in which children were

  • offered a choice between one small reward provided

  • immediately, or two small rewards if they waited

  • for a short period, which was about 15 minutes, during which

  • the tester would leave the room and then return.

  • The reward was sometimes a marshmallow, but often

  • a cookie or a pretzel.

  • In followup studies, what these researchers found

  • was very surprising.

  • These children who were able to wait longer for the preferred

  • rewards tended to have better life outcomes

  • as measured by SAT scores, educational attainment, body

  • mass index, and other life measures.

  • Now why am I mentioning this?

  • Our guest today is no psychology professor.

  • But he happens to be a Stanford alum.

  • And he happens to be a world famous value investor.

  • In speaking about his investing process and philosophy,

  • you will see parallels between delayed gratification.

  • Let me share a quote from his recent interview

  • with all of you.

  • He describes his process saying, "We

  • tend to benefit in life when we sacrifice something today

  • to gain something tomorrow.

  • That is true for companies.

  • That is true for individuals."

  • His focus, he says, is on businesses

  • that have the capacity to suffer, that is, they can

  • reinvest their capital at high rates of return

  • so that the wealth will continue to compound

  • into years into the future.

  • Thomas Russo, our guest, is a preeminent investor

  • of our times who began his investing journey in 1982

  • after an encounter that changed his life.

  • He was studying law and business as a graduate student

  • at Stanford when Warren Buffett came to address his investment

  • class.

  • As Mr. Russo explained in a recent interview,

  • he was dazzled by the speed of Buffett's mind,

  • his quirky delivery, and his beguiling

  • habit of courting everyone from Bertrand Russell to Yogi Berra

  • and the wisdom of his deeply thought ideas.

  • This inspired him to finding his own investment vehicle

  • and starting his value investing journey.

  • We are so glad that he's here in person

  • to share his experience and his journey

  • and his insights with all of us here.

  • Thank you for coming.

  • So without any further ado, ladies and gentlemen,

  • please join me in welcoming the one and only Thomas Russo.

  • [APPLAUSE]

  • THOMAS RUSSO: I'm so pleased to be here.

  • I actually thought the setting would

  • be a much different setting.

  • I thought we'd be underground in some catacombs with a group

  • of people worshipping an outlawed

  • faith in Silicon Valley, the faith of value investing.

  • But here we are, next to the free food,

  • the wonderfully lit room, great chairs.

  • So being a zealot in the investment business today

  • doesn't bear the marks that it did 2000 years ago

  • for religious zealots, I guess.

  • It's a great honor to be here, especially at this time.

  • It's a really good excuse to get away from the markets, which

  • is something that's welcome.

  • Even though I say that, we've had an unusual period of time

  • which reaffirms what [? Surapa ?] described

  • as this value investing preference for businesses that

  • have the capacity to suffer, because you think

  • about my last three years, we've certainly suffered when

  • compared to the S&P 500, which has been elevated by sort

  • of global capital flows.

  • And we've had businesses that, right through this,

  • have been investing in their strong global brands,

  • but showing a modest growth at the reporting level

  • because they often invest a portion of their net profits

  • against future business prospects.

  • Now recently, almost a third of our portfolios in beverages--

  • and the world is now quite reaffirmed about the value

  • of beverage brands through the noise about the AB InBev

  • acquisition of SABMiller-- we own both those shares,

  • and it's helped generate performance recently

  • in the face of a plunging market.

  • And then I was reminded of this again today, which

  • was the results of an announcement by JT Tobacco

  • to acquire American Spirit from Reynolds American Tobacco.

  • Well, quite extraordinarily, the price

  • was almost Silicon Valley-like.

  • It was 300 times operating income

  • for a business-- they paid $5 billion for a business

  • that I think had around $500 million in revenue,

  • much smaller base of profits because it's still

  • investing in its own growth.

  • But they saw something that they could take around the world.

  • And it reaffirms-- within a business like RJR,

  • where people often overlook the investment

  • because it lacks sizzle-- that the strength of the brand,

  • the predictability of cash flow, and the ability,

  • most importantly, to reinvest that cash flow going forward--

  • leaves it quite valuable.

  • I'm going to come over here so I can move some of these around.

  • I did, in fact, also welcome the chance

  • to come up because I'll talk tomorrow

  • to the students in Professor Jack McDonald's class, which

  • I've done for the past 25 years, having

  • graduated from his class.

  • And it was there that Buffettt came to our class

  • and provided some early insights.

  • I'll go through a couple of quick slides.

  • As an investor, you're always, at least in the value investing

  • world, encouraged to invest for the long term

  • and let market disruptions pass you by, hold on.

  • And I was reminded of this in June of 2008,

  • when I was in Africa with my family on a safari.

  • And every day we'd go out to visit the range

  • and look for animals.

  • Each one looks more ferocious than the next.

  • And every single time, the guide would say, look,

  • if you're ever separated from the group, and you're alone,

  • and you're being charged by a lion or anything

  • else-- a chameleon, anything that

  • might come at you-- freeze, and it'll ignore you,

  • run right past you.

  • But if you run, they'll chase you down.

  • That was the rule again and again and again.

  • Finally we came upon this guy.

  • And he said that, that's a Cape Buffalo.

  • If ever you're alone and you're separated from the group

  • and you see one coming charging at you, run like hell.

  • And so that happened in June of 2008,

  • when the market was just in free fall.

  • And at the time, I sort of felt like maybe we

  • should run like hell.

  • We didn't, and we haven't.

  • It's my belief, it's been my belief,

  • that equities are the preferred form

  • of investing for one capable of enduring short-term pain

  • for long-term gain.

  • Equities will be the best way to do that.

  • And along that line, I would just

  • want to make a point about this other Stanford experiment

  • that you referred to.

  • I do believe definitely in deferral in the investment

  • world-- as you can see, a little less as it

  • comes to marshmallows.

  • I tend to grab the big ones and eat them quickly.

  • But the principle's the same.

  • In fact, I incorporate the principle in one

  • of the early lessons that Buffett

  • gave at an annual meeting of Berkshire, where he said,

  • you know, really, investing is as simple as "Aesop's Fable."

  • It's about the bird in hand versus the bird in the bush.

  • The only thing you need to know-- because you know what

  • you have-- what you need to know, which is uncertain,

  • is what you'll end up with when.

  • And he says, it's as easy is that,

  • and then he says, it's as hard as that.

  • I'm in an audience at Google.

  • And I think I read that the minutes spent

  • on YouTube in the last second quarter versus the prior year

  • was up 60%, and that's on a million users.

  • And I can tell you that if you keep up that type of growth

  • rate, it won't take that long.

  • You'll know what you're going to have, which is a lot,

  • and it's going to happen soon.

  • But in most businesses you're not

  • blessed with 60% growth rates.

  • There's something much less commanding.

  • But it is about what you'll end up with.

  • And so I think that's a good emblem.

  • This I take from one of our largest holdings,

  • which is Nestle.

  • They, like Google, talk extensively

  • about corporate culture, because that

  • is what you can bank on when you make an investment.

  • We own businesses that are supposed

  • to reproduce themselves over time,

  • and you need a strong culture.

  • And the head of Nestle's Japan business once showed this slide

  • and remarked about how lovely he thought

  • that 700-year-old temple was.

  • And then he said, now, none of the wood's 700 years old,

  • but the temple is.

  • And I thought of that as sort of an apt metaphor

  • for what businesses are like.

  • I mean, none of you will be at Google at some point,

  • but Google will hopefully still be Google.

  • The timbers are all changed out here,

  • but it still stands for the same thing.

  • And you'll be a very different company when you're all gone.

  • But Google should still stand, in light

  • of its context at that time, as a business

  • with the same virtues and values as it is today.

  • And that corporate culture is extraordinarily

  • important to myself because most of the money that I oversee

  • is invested through me by wealthy families, family

  • offices.

  • And for them, it helps a lot to hold a business

  • for a very long time.

  • And the only way you can invest based

  • on that belief is if you get the corporate culture right

  • I came out of Warren Buffett's visit to my class in 1982

  • at Stanford Business School with a couple of sets

  • of information captured here.

  • First, the $0.50 dollar bill.

  • That used to be the old-fashioned way of thinking

  • about value investing.

  • If you buy $0.50 dollar bill, your margin of safety was quite

  • great because of the discount.

  • Your internal rate of return, however, depended exactly

  • on when that discount closed.

  • And if it closed in a year, you'd make 100% on your money.

  • If it took 10 years, you'd make 7% on your money,

  • and so on through the Rule of 72.

  • It's also problematic because it's taxable.

  • So in that old model, if you took that $0.50 dollar

  • and realized the dollar, you'd pay 40% tax on that now

  • because long term gains have been less favored.

  • And you have to redeploy the money

  • into finding something else.

  • That didn't seem like much of a thoughtful way

  • to conduct affairs from my perspective,

  • especially since, at business school,

  • Warren gave the class the primary benefit.

  • He talked about the only one thing

  • that the government gives you as an investor, which

  • is the non-taxation of unrealized gains.

  • They give you one other thing, which

  • is that you can deduct losses for tax purposes.

  • But you don't you want to go there.

  • You're much better off finding something

  • that you could hold so that the gains that you get over time

  • are unrealized.

  • So when he spoke at our class, Berkshire

  • traded at $900 a share.

  • Today it's at $200,000 a share.

  • It's never paid a dividend.

  • It's never done anything except compound.

  • And it's only because he's been able to reinvest

  • at such a high rate internally.

  • And rather than try to close the discount, the discount that we

  • started with, he just let the intrinsic value

  • compound and the market price will track it over time.

  • It

  • Warren also said that there aren't

  • that many good businesses in the world.

  • As an investor you should select a business

  • that you find interesting so you would follow it

  • and you spend more time with it.

  • For me, that was consumer brands.

  • Early Buffett investing was sort of

  • transformed once Berkshire bought See's Chocolate

  • in the early '70s.

  • And I heard from him early into that exercise,

  • but he already had realized that See's gave him the ability

  • to raise prices regularly, because the consumer doesn't

  • believe that there's an adequate substitute for the brands

  • that they embrace.

  • I recognized that once flying on an airplane,

  • and the person next to me ordered a Jack Daniels.

  • The steward said, sorry, we just have Jim Beam, and he said,

  • I'll have water.

  • I'd rather have water than the one

  • that I don't really identify with.

  • And that brand loyalty, by the way,

  • is what we look for at the heart of our businesses.

  • That gives pricing power, that gives predictability of demand.

  • In fact, it's that brand loyalty that, at some point,

  • you guys are involved with creating and sustaining

  • through all of the work that happens at Google.

  • But that's the sort of uber brand value

  • rather than the search brand value.

  • So we can talk about that later on,

  • because I'm intrigued by Google.

  • So what did Warren say?

  • He said margin of safety's required.

  • The $0.50 dollar bill, however, changed by the time I met him,

  • because he realized that a business that can price has

  • the ability to grow, and that growth is more powerful than

  • discounts of inert value.

  • He said, observe the tax efficiency of holding.

  • And then he said, you're probably

  • going to have to find managers who are owner-minded if you're

  • going to hold for a long time, because otherwise they'll

  • steal from you.

  • So the question is agency costs, and that's actually

  • at the heart of the investment contract

  • that you have with your public company managers.

  • There is a contract that says, you'll have the use

  • of my money, my investors' money,

  • but you have to treat it as if it's your own.

  • You can't prefer your returns to their returns.

  • That's very hard to find.

  • And so in my world, where I found it to be available

  • is through family-controlled companies

  • where the family exercise dominion on their own rights

  • over the management to do what's right for the next 10

  • generations of the family.

  • That's starts to feel comfortable to me because

  • of my long-term mindedness.

  • I like businesses that invest for the very longest term,

  • and do so with the owner in mind rather than management.

  • The average US public company, by contrast,

  • has no family entanglements.

  • It's purely public.

  • There's absolutely no image of a shareholder

  • when people think about the contract.

  • I actually met the CFO of Coca Cola recently,

  • and she referred to shareholders as stakeholders, and I said,

  • don't you really mean owners?

  • Because the word stakeholder-- I mean,

  • you could be a stakeholder if you're the community,

  • if you're this or you're that.

  • There are all these concepts.

  • But in business, what you really want your agents to think about

  • is the owner at some level.

  • Public companies are so far removed

  • from that it's not even funny.

  • Really, it's the idea of how do you make the public company's

  • money manage its money?

  • The most efficient way designed to do that are stock options.

  • And stock options have one problem,

  • which is the only work over a specific period of time,

  • after which, if the prices isn't struck,

  • they end up being worthless.

  • So the one thing public companies

  • start to spend an awful lot of time caring

  • about, way too much, is time.

  • They need it now.

  • And in fact, Wall Street loves companies

  • that are willing to present things early on because it

  • means that they can predict more clearly what the world's going

  • to look like than what natural outcomes ought to allow.

  • So they can say, General Mills is going to earn $1.50 this

  • quarter, and General Mills will earn $1.50 this quarter.

  • They won't really earn it, but they'll report it.

  • And they'll do that again and again and again.

  • And then over time, by taking steps

  • that get the outcome, to meet the target,

  • to keep the share price up-- because there's no volatility,

  • it's all predictable-- they hollow out the franchise.

  • Just the opposite of what we're looking for.

  • We're looking for businesses that

  • are willing to completely thrash the near term in pursuit

  • of the long term.

  • But in order to do that, they have

  • to have security in one issue, which is control.

  • That's where the family-controlled company

  • comes into play, because they can, with their super vote,

  • defend against the pressures that normal managements are

  • willing to assume in the complicit bargain

  • that they have with stock option-driven compensation.

  • I'll fast forward for a second.

  • I pulled this from the Google founding principles.

  • And right at the heart of what Google talks about,

  • and what I think gives you such endurance,

  • is this structure, this third paragraph down,

  • second sentence. "This structure will also

  • make it easier for our management team

  • to follow the long-term innovative approach emphasized

  • earlier."

  • They have the management's back covered,

  • and they allow, from that standpoint-- investments have

  • a very long payback, but upfront burden

  • to take place at full amounts, because it's

  • my belief that most public companies, the error

  • is on under-investment upfront to make sure

  • that the results are, in effect, overstated.

  • Now I use the term capacity to suffer.

  • It's a funny one.

  • It was partly derived from another investor

  • you may have met with or heard of called

  • Jean-Marie Eveillard, who runs SoGen's International Fund.

  • He was quite an early international investor.

  • And at a Columbia function I was at,

  • the business school, somebody asked him

  • what he looked for in analysts when he was hiring

  • to build as investment team.

  • And without a moment, he said, the capacity to suffer.

  • And I thought that was an appropriate definition.

  • And the reason he said that is that it's so rare to find

  • that in America, because as a country,

  • we always think that every single day should be better

  • than the prior day.

  • Actually, there's a great quote in the book

  • that I just read, "Work Rules."

  • And he talks about a guy who was in a cubicle, and he said,

  • every day of his life is worse than the day before.

  • That's the capacity to suffer.

  • But in the investment world, the capacity to suffer

  • is hard to find.

  • People expect returns to come easily, regularly,

  • and they don't.

  • And so his recognition was that you

  • have to have people in the investment

  • business constitutionally prepared

  • to have deferred results.

  • All right.

  • So if we start out believing that we're

  • going to hold something for a very long time, what

  • it needs to have is the capacity to reinvest internally.

  • For me, I used consumer brands as the industry

  • through which I invest because they tend to be very enduring.

  • You think about Communist China.

  • After the veil lifted and commerce could go back in,

  • the number one cigarette in Communist China the next day

  • was a cigarette that hadn't been in the country

  • for 55 years of Communism.

  • It was the old British American tobacco

  • brand called State Express 555.

  • Hadn't been in the market, but somehow it was still

  • in the brains of the consumer.

  • Same thing with Romania when the wall went down in Romania.

  • The number one thing that the Romanians wanted

  • was Chesterfield cigarettes.

  • Well, you can't even find them anymore.

  • But that brand endured for 55 years in the consumer psyche.

  • And what we look for is the ability

  • to reinvest behind those brands.

  • The strength of the brands tend to allow

  • for more regular free cash flow because of the pricing power

  • that you get.

  • The likelihood of finding owner-minded businesses

  • goes up with consumer brands because they

  • tend to have been, over the life of the company, more

  • self-funding.

  • You think about why it is that most American companies don't

  • end up with control shareholders,

  • because if you're in a crummy business,

  • it takes a lot of money to grow.

  • And you have to raise additional equity again

  • and again and again to fund the growth.

  • And at the end, if it's a sufficiently competitive crummy

  • business, you're going to have horrible results and no control

  • shareholder.

  • The presence of a business that still

  • has control held by the family is an evidence of the fact

  • that the business is, at its heart, quite cash generative.

  • Now it's not enough just to be cash generative.

  • What you really want is to have the capacity

  • to have that cash that the mature markets deliver,

  • in the world of consumer brands, available for reinvestment

  • globally where 95% of the world exists in population,

  • and where GDPs are escalating, and where

  • consumer disposable income is just growing.

  • And so we want to have brands that have relevance abroad,

  • which gives them the capacity to reinvest mature market cash

  • flows into growing markets.

  • It leads this portfolio that I oversee

  • to be primarily European.

  • That's for a couple reasons.

  • One, the European managements aren't nearly so accustomed

  • to compensation based on equity options.

  • And so this notion of having to do something

  • quickly-- and fabricate numbers to make sure

  • that the Wall Street analysts are pleased enough

  • to keep the stock price high enough for your options

  • to be worth something-- doesn't exist over there.

  • They pay people cash.

  • The brands that exists in Europe have been abroad more

  • historically, and hence are more embedded in the culture.

  • In India you have Hindustan Lever.

  • Well, that's Unilever.

  • You have Cadbury of India.

  • That's Cadbury Schweppes.

  • You have Nestle of India.

  • They've been around, in the case of those three,

  • for at least 50 years.

  • And their aspirational character was developed

  • over that period of time.

  • And that aspirational character gives pricing power.

  • And that pricing power allows for reinvestment.

  • So we're looking for global brands.

  • We like the developing emerging markets,

  • because that's where the newly formed demand is arising.

  • That's where the markets are un-invested in.

  • And that's where GDPs are rising.

  • Everything I'm telling you, actually,

  • was more true as a context two years ago than today.

  • If you think about the stories of the current world, collapse

  • of commodity prices, pulling back of manufacturing,

  • China coming back.

  • So lots of what I've built into my investment thesis

  • is sort of in flux.

  • And it's an interesting time.

  • But it certainly has been, for the past 25

  • years of the course of my investment

  • creator, a one-way tailwind, the opening up of markets

  • leading to the transparency and liberalization of societies,

  • leaving people free to buy things that they'd long aspired

  • to, leading our companies to have a place

  • to pour back their free cash flow into meeting

  • that consumer need as a group.

  • What else do you need?

  • And this also favors international community.

  • One thing you need to expand internationally--

  • if that's where your growth is going to come from-- you

  • better have multilingual and multicultural managers.

  • Multilingual surfaces quite quickly.

  • In this audience, how many people

  • here speak more than three languages?

  • Good It's rare.

  • It's really rare in North America.

  • It's not at all rare in Europe.

  • So at Nestle, I think the top 100 people in the management

  • team speak four languages.

  • And at Kraft Foods in Illinois they speak 0.9.

  • Multicultural.

  • That's important.

  • Let me ask somebody a question here.

  • How many people-- just by raising your hand--

  • how many people have a favorite cricket player?

  • See, you're a very unusual company.

  • That's what makes Google great.

  • Nowhere else, if I ask that question,

  • will a single hand go up.

  • 1.7 billion people go to sleep each night

  • thinking about their favorite cricket player.

  • And if you're going to be effective internationally,

  • you probably want to have somebody who

  • understands that story line.

  • So the capacity to reinvest is not democratically shared.

  • I made light of Kraft.

  • Indeed, we had and sold all of our stake

  • in Kraft because of their provincial portfolio

  • and their lack of natural reinvestment.

  • They tried to go into China, they failed, they came out.

  • They had no people to develop the market.

  • They didn't understand it.

  • And it's a domestic company, and it's

  • a company that's made lots of money selling cheese

  • and cookies and meat to Americans.

  • And America was a big enough market

  • that it kept their ambitions fully staffed.

  • But they had no capacity to go internationally.

  • We want businesses that can.

  • Nestle, Unilever.

  • They have the bench strength, they have the brands,

  • they have the cash flow, they have the understanding

  • of where the puck's going.

  • Now in order to do it the right way,

  • you have to have the capacity to suffer.

  • That means that when you open up a new market,

  • you're going to have unabsorbed fixed costs in spades,

  • and that will burden current income.

  • If you're not protected through major shareholders who

  • support that long-term vision, I can assure you-- today

  • especially so-- you will have any number

  • of a dozen different activists come in by 1% or 2%

  • of your company and demand better.

  • You can do better.

  • If not, we'll kick you out.

  • And no management team wants to do that, especially midway

  • through an investment cycle.

  • I'll give you a quick example.

  • We own shares of Cadbury Schweppes.

  • It's a terrific business.

  • They had three pillars.

  • They had gum, chocolate, and hard candy.

  • Each one of those came from a different background.

  • in Each one was dominant different parts of the world.

  • Put it all together.

  • They had great market presence in parts of the world that

  • had been massively underserved.

  • The joy of eating sweet things.

  • So what do they do?

  • They decide that they try to launch the business in China.

  • And they start out in Hong Kong, Beijing, and Shanghai.

  • And they knock the ball out of the court, everyone

  • believes it's a good business.

  • The Chinese line up.

  • They like it.

  • They go to 200 of the next cities in line.

  • So that takes you down to cities of a million or more,

  • but there are 200 of them.

  • Now the suffering really starts.

  • Now they're spending a lot of money.

  • They have to introduce the brand,

  • they have to build awareness and all the rest.

  • And they do it across 200 cities.

  • Now I heard from the CEO of the company sort of midstream

  • through this.

  • He understood that the investment spending

  • was going to just overwhelm the reported profits out of Hong

  • Kong, Shanghai, and Beijing.

  • In fact, they'd show losses for as long as they could see.

  • And every year that went by and they invested like this,

  • they built net worth because they converted consumers

  • who became loyalists and who had lifetime consumer patterns.

  • And you can know the upfront value of a converted customer

  • addicted to sweet things.

  • They were midway through the process, losing a lot of money.

  • Along comes Nelson Peltz, knocks on the door and says,

  • you gotta do better.

  • The numbers just aren't advancing.

  • You have to do something.

  • Give us some earnings.

  • So the board and the CEO went home over the weekend,

  • came back and said, right.

  • We think we have China wrong.

  • That investment work we're doing in those 200 cities.

  • We're way out in front of our skis.

  • It's just not working.

  • Let's close it.

  • Now with that, they manufactured income

  • because they stopped bearing the costs

  • of investing for the future.

  • They destroyed wealth, because all the people

  • who had bought on board the brands now no longer could

  • source them.

  • And away went the equity, the goodwill

  • that they had created through that investment spending

  • midstream.

  • And they lacked the capacity to suffer,

  • because when a raider came and rattled their cage,

  • they said fine.

  • We'll do just what you need.

  • We have a handful of examples here,

  • which I'll go through quite quickly.

  • I'd say the best example of a company,

  • too, that had the capacity to suffer.

  • One is inside this room.

  • You know, you think about all the kind of projects

  • that Google incubates, burdening profit

  • with an idea, maybe, of where it'll end up, but in some cases

  • not even.

  • That's extraordinarily powerful.

  • And you have lots to show as a result of that.

  • That scale would be a very interesting one,

  • because I think you have an awful lot

  • to show for the willingness to suffer.

  • And Amazon.

  • Amazon's way out, even beyond you guys.

  • I'm not sure that they'll ever report a profit.

  • But they certainly have the capacity to suffer.

  • So do their shareholders.

  • Well, of course they get rewarded for it.

  • The price has gone up so much.

  • So the businesses that we'll look at are more traditional.

  • Berkshire is the best one.

  • That's why I learned this subject.

  • Warren talks about it all the time.

  • But Geico's a great example.

  • Much like confectionery in China,

  • it's expensive, it turns out, to bring on an auto insured.

  • And so when Warren bought controlled Geico,

  • he asked the CEO why they only had two million policyholders,

  • and the CEO said, because it's too expensive to grow.

  • Every new policy we put on the book

  • loses $250 in the first year.

  • And ongoing insured make $150 per year of operating profit

  • for the company.

  • So you have two million policyholders making $150 year,

  • so they were reporting $300 million of profits.

  • And if they wanted to grow a million new policies

  • the next year-- because as Warren said,

  • they had the best business, under-penetrated,

  • the market should have more of them.

  • So why not grow it by a million policyholders?

  • What would happen to the operating income that year?

  • It would go from 300 to 50 assuming

  • that the other business didn't grow at all.

  • Now no public company can endure that kind of volatility.

  • The activists would be on that thing so quickly.

  • Inside Berkshire, it didn't matter.

  • Warren controls 40%+ of the stock.

  • He's never told investors that he's

  • in the business of manufacturing reported earnings.

  • No one get stock options.

  • He gets paid $100,000 a year.

  • It's all about owner's equity, intrinsic value,

  • and how do you grow that with certainty as best you can?

  • Well, no better reinvestment than to take that $2 million

  • insured base up because of its persistency and its low claims,

  • lack of adverse selection as they grew.

  • They had a lot of room.

  • And by the way, even though the first year cost, reported loss

  • of a new insured was $250 upfront,

  • the moment they signed up the net present value, lifetime

  • value of each insured, $2,000.

  • That's $150 stretched out forever, brought back.

  • Now, so for the mere inconvenience

  • of reporting a $250 loss upfront,

  • they put on $2,000 of value.

  • Warren got it.

  • Today, 14 years later, they have 11 million policyholders.

  • And in the annual report he said to investors,

  • because he's a fair partner, if you're

  • thinking about selling the business, your shares

  • in Berkshire, understand that book value doesn't capture all

  • that we've got that's good.

  • And he said, for instance, at Geico we've added $20 billion

  • of value since we bought it.

  • Now that's that $20 billion that comes

  • from those 9,000 new insured.

  • And the only way you get there is

  • by having the capacity to let the income statement

  • bear the burden.

  • And over that time, they took their annual ad spending

  • from $30 million up to $1 billion.

  • And you'd all know that, because watching television

  • is really a series of Geico advertisements these days.

  • Another thing that Berkshire did was,

  • the equity index put options.

  • There's a group that had $37 billion

  • worth of equities, market value equities,

  • around the world for different markets.

  • And whatever the reason, that group

  • had to be able to say to their counterparties

  • that that $37 billion was not at risk.

  • They needed for their collateral,

  • whatever the reasons, to have $37 billion.

  • And so Warren was asked to insure

  • against the potential for that portfolio to decline in value.

  • He sold them a put option.

  • In return, we received $5.3 billion to invest,

  • unfettered, for 18 years.

  • It was non-callable and it had no collateral

  • posting requirements, which are the killers in this business.

  • So why did Warren get $5 billion to insure

  • against the decline of equities over 18 years

  • when, likely, the course of equity values is up over time?

  • It's because the people who needed that insurance

  • had nowhere else to go.

  • First, Warren had the capital.

  • He had $50 billion of spare cash which sort of buttressed

  • his claims-paying appeal.

  • Other people who might take the $5 billion

  • don't have the capital balance sheet or the culture

  • to provide for the ultimate payment

  • if the world went to zero and they owed $37 billion.

  • Warren has that, and the culture would honor that.

  • The other thing, the more important thing,

  • was nobody else would touch this stuff,

  • because every quarter there is a mark to market requirement.

  • And it absolutely crushes reported profits.

  • So for example.

  • After they signed it, received the $5 billion,

  • the equity world markets collapsed

  • and they had six quarters in a row of over $1 billion

  • worth of charges to the income statement,

  • some periods as much as $3 billion,

  • because global equities collapsed.

  • And every time it collapsed, they'd

  • have to pass through the reported profits,

  • the mark to market.

  • OK.

  • So at the end of the day he had $13 billion

  • less in earnings cumulatively over that time.

  • But he had $5 billion which he had put to work.

  • And that's sort of the last story about Berkshire.

  • Another way in which you could see his capacity to suffer

  • added enormous value was that during the crisis-- well,

  • during the period leading up to the financial crisis of 2007

  • and 2008, Warren, at the annual meetings,

  • always lamented the fact that he had $50 billion cash hanging

  • around on which he was only earning .01%.

  • And that's the safe return.

  • That's sort of the federal treasury bills that are secure.

  • Since he kept it in cash, he might as well keep it secure.

  • But he was only making .01%.

  • 01%.

  • If he had standard company practices,

  • he never would have kept $50 billion of cash

  • in overnight money.

  • He would have gone out three, 10, 14, 40

  • years on a bond portfolio and would have had a 4% yield.

  • He kept it at .01% because he didn't trust inflation

  • or credits to support having $50 billion

  • in longer duration investments.

  • The difference between 4% and 0.1% on $50 billion

  • is $2 billion a year.

  • That's the amount he suffered by under reporting,

  • because he kept his money in liquid treasuries.

  • That requires a lot of suffering because $2 billion

  • is a lot of money, even to Warren.

  • Now ironically, to show you how American companies behave,

  • at the same time that Warren was belly aching about only making

  • .1%, General Electric had taken $100 billion of their borrowing

  • and brought it into commercial paper overnight

  • to capture those same low rates.

  • Now it's a different story for General Electric, though.

  • You have businesses that have long-term funding requirements

  • where you can't responsibly borrow overnight to meet.

  • You can do so if your goal is to manufacture earnings.

  • And off $100 billion in the overnight market,

  • where they might be earning 2%-- they may be paying to 2/10

  • of 1%, let's say, maybe even .03% in the commercial paper

  • market-- they should have been paying 4%, exactly like Warren.

  • In their case, they should have stretched out their liability

  • structure.

  • But by taking it all into commercial paper,

  • investment bankers assured them that they could swap them out

  • at any minute.

  • They could go back long.

  • They could go into yen, any currency they wanted.

  • It was just a number after all, wasn't it?

  • Well, they forgot one thing, which

  • is that overnight markets can shut down.

  • And when Lehman burst, GE had $100 billion of overnight money

  • that they couldn't roll.

  • Warren, happily, had $50 billion which

  • he could use to help them out.

  • And he gave them the right to $12 billion of his money

  • at 12% with hundreds of millions of shares of call options.

  • In case the company did well, he would

  • have the privilege of making the equity that they recklessly

  • threatened by their non-owner minded ways.

  • Now they were not at all unusual in this.

  • This is what public companies do.

  • They bring down the rest of the cost because it helps flatter.

  • In GE's case, that was $4 billion of manufactured income.

  • Now this I would complain to you about.

  • However, there's one mega force on the landscape that's

  • done one worse than that, which is the United States

  • government.

  • We have taken our borrowing from $9 trillion to $18 trillion

  • through QE, most of which was not invested but was

  • transferred, to try to stimulate some kind of economic growth

  • in the absence of a Congress that doesn't meet.

  • And we keep that money predominantly

  • in overnight borrowings.

  • The yield curve of the US Treasury

  • is abysmally short term, and we are massively

  • understating, when we look at our own deficit, what

  • this country has put itself into, which is $9 trillion

  • of additional borrowing coming through at sort of 1, maybe 1,

  • 1.5%.

  • And the real cost of that burden will

  • be very apparent at some point when rates go, uncontrollably

  • by us, upwards beyond our control.

  • Anyways, I hope that what, for me,

  • has been most educational from the time

  • I first heard Warren speak at Stanford to the present--

  • this notion of how the capacity to reinvest surfaces

  • is best illustrated by those three ideas in Berkshire.

  • And there have been a whole series of business

  • that have done it afterwards.

  • Nestle is extremely well-positioned

  • in the landscape of what I look at by virtue

  • of having all these billion-dollar brands widely

  • v distributed throughout the emerging markets,

  • aspirational, and available, increasingly,

  • due to the hard work of multilingual, multicultural

  • people delivering their business.

  • The company does not hurry.

  • When I first invested in the business's shares, 1987,

  • the CEO then, because of Wall Street's miserable reaction

  • to their patience, said, well, what

  • is Nestle's planning horizon?

  • This is the CEO.

  • And he said, without a flinch, he said, our planning horizon

  • is 35 years, but we tend to break it up

  • in five-year increments.

  • Now this is what you want of a company

  • if you're thinking long term.

  • I think American companies have a 35-minute, not

  • year, planning horizon.

  • This graph, I think, just demonstrates

  • what it is that we're about, what we're going for,

  • which is on the far left, as you look at low per capita GDP,

  • and then you move up to the right,

  • you go from subsistence to buying, to buying better,

  • to buying luxury.

  • And there are two or three billion people

  • in the world sort of at the far left of 2,700.

  • I think in China now today it's 7,000 GDP,

  • but it's bifurcated badly, probably 500 million

  • of less than 1,000.

  • In India there's half a billion less than 1,000

  • in the rural areas.

  • The country's probably much higher.

  • But it's that migration from subsistence with no commerce,

  • to commerce, into brands that we're in the midst of.

  • And that's what we invest behind.

  • The company has the patience on reinvestment.

  • If you look at the very top of this little chart

  • you'll see in Nespresso.

  • Very, very top.

  • It's a business that they pioneered about 20 years ago.

  • It took them 15 years-- maybe it was 25 years, I don't know.

  • It took them 15 years before they broke even

  • on that business.

  • They lost nothing but money for the development phase.

  • And they built it right, and they tested it.

  • And along the way, when other competitors

  • had wind of what they were doing,

  • they came out with products that were not nearly so competitive,

  • like Tassimo by Kraft, and some others who were

  • more interested in short term.

  • Nespresso built their business to last,

  • and today they do $5 billion of business.

  • Now it's not an unblemished record,

  • because Keurig's a huge business.

  • They should have shut them down.

  • And Starbucks has grown to be an enormous presence in the coffee

  • business, and they probably should

  • have been more adept at that.

  • But they still, nonetheless, had the capacity

  • to deliver a truly great business in Nespresso, which is

  • what these boutiques look like.

  • Let's think here.

  • We could go on.

  • I'll just give you a quick overview.

  • Pernod Ricard, great portfolio of spirits.

  • Two in particular, Martel and Chivas,

  • they acquired through Seagram's.

  • When they bought it, it was in the year 2000.

  • China was going through a downturn.

  • There was a company called LVMH and Diageo, who owned Johnny

  • Walker and they own Hennessy.

  • And those were the two largest brands in China from the west.

  • At the time they were about two million cases.

  • At that time, Diageo said, OK, China's going into a funk.

  • We'll just pull out because we want to protect our income,

  • our reported profits.

  • Why spend the money now when the market's turned down?

  • We're probably not going to get a lot of yield from that.

  • Let's take our brands home, maybe come back later on.

  • At that time, Pernod Ricard had just

  • acquired Seagram's, and with it came Chivas, like Johnny

  • Walker, Markel like Hennessy.

  • And they said, well, you know what?

  • We're a family.

  • We own the business.

  • No one can take us out.

  • We don't have to worry about reported income.

  • Why don't we go in and see what we can do?

  • Now since then, obviously, China has recovered.

  • Chivas and Martel succeed.

  • They're not the largest Western imported spirits in China.

  • Diageo struggles to get relisted in the country

  • that they once commanded but left.

  • They left for the wrong reason, which

  • was maintain that earnings per share, because why not not

  • suffer if you don't have to?

  • Well, they should have stayed.

  • The long-term prospects of this business,

  • however, are not yet scratched.

  • The white space, looking forward in their portfolio, in China

  • there are half a billion cases of baijiu, local spirits

  • consumed per year.

  • All of the premium Western businesses, in total,

  • do only four million cases.

  • So we've got 549 million cases that we can go after.

  • And an agitant to this will be the great growth

  • in the Chinese tourists.

  • There'll be over 100 million tourists this year from China.

  • As they go to Europe, they observe.

  • They're already minded towards those western trademarks.

  • And they'll come home with a couple of bottles

  • through duty free and start to sort of serve

  • as local ambassadors for the brands.

  • I think less than 1% penetration over time

  • will be a very attractive platform from which

  • we will grow these businesses.

  • In India, if they weren't the case

  • that the government has had such barriers to trade,

  • we could see that business even bigger.

  • I would ask the question of anybody here

  • who travels duty free into or from India,

  • what two bottles of spirits does every Indian buy

  • when they return home?

  • Yes.

  • AUDIENCE: I don't know if it's typical,

  • but I buy the Glenlivet.

  • THOMAS RUSSO: Oh, you're very high end.

  • AUDIENCE: [INAUDIBLE]

  • THOMAS RUSSO: Oh, you're high end.

  • No, it's Johnnie Walker Black Label.

  • The numbers, Black Label's the big one.

  • But the Indians consume 125 million cases

  • of what looks like scotch, locally made.

  • Imports are very thin.

  • And Puerto Rico controls the market, along with BJ

  • [? Maya ?].

  • But when and if-- well, I guess I'd say,

  • because of what Modi said yesterday at the SAP Center--

  • when, not if, free trade descends,

  • we will sell so much scotch whisky, authentic whisky,

  • into a market that prefers it over their local brands

  • that the investments in Diageo and Pernod Ricard

  • will just, I think, be pulled along.

  • In the meantime, they're suffering.

  • They're not absorbing their costs

  • because it's expensive to maintain market presence

  • and only sell at the very highest end because of trade

  • barriers.

  • Anyways, Pernod, I think, it stands

  • where it does because again and again and again,

  • like in 2000 with China, the family

  • has the ability to out-compete standard public companies who

  • worry about stock options and quarterly numbers

  • because they're free to think long term.

  • And if you sat there and watched a public company dismember

  • their premium status in China, and you said,

  • but for quarterly earnings they would've stayed,

  • and you go in to that void, it's a terribly attractive

  • structural advantage.

  • I think we pick up by sticking with these businesses.

  • SABMiller.

  • I like this slide.

  • It's now, unfortunately, in the midst of being taken over,

  • which is a disappointment because they

  • had the right mindset.

  • They were South African breweries. .

  • They were a pariah company.

  • They started with nothing.

  • And today they are the second largest brewery

  • in the world, maybe the largest because

  • of the Chinese operation.

  • When they invest to develop the future,

  • however, look what happens to the EBITDA margin.

  • Revenues went up a lot over this period of time.

  • This is some time back now.

  • Revenues went up a lot as they were pouring money

  • into developing the markets throughout Africa that they

  • had a toehold in, but recognized at some point

  • that they were under investing.

  • They stepped up the investment massively,

  • grew revenue, grew volumes.

  • EBITDA margin plunges.

  • That's good.

  • That's the burden on reported profits

  • that came from the upfront development costs of opening up

  • those markets.

  • They had the ability to absorb that because of the control

  • shareholder group.

  • And Brown-Forman's the last one I'll talk about.

  • It's ironic.

  • This is how screwed up America is.

  • In Brown-Forman's case, what I call the virtue of family

  • control, which is the alignment of interest

  • for the long term, which means that they're often treated more

  • cheaply in the marketplace because people

  • worry about corrupt families.

  • But the irony is that instead of celebrating family control,

  • in their proxy statement, they have

  • to have a section that says, "A risk factor is

  • a substantial majority of our voting stock

  • is controlled by members of the Brown family,

  • and collectively they have the ability

  • to control the outcome of shareholder votes including

  • this and that.

  • We believe that having a long-term

  • focused commitment and engaged shareholder base provides us

  • the important strategic advantage, so on and so forth."

  • However, they flag it as a risk factor.

  • I celebrate it as really one of the great things.

  • And I first invested in their company in 1987.

  • They had made a bunch of investment banking-driven

  • acquisitions, all of which flopped.

  • And at that point they committed as a family to do nothing

  • but grow Jack internationally.

  • Wall Street despised the shares.

  • They had sharply declined when I made the investment.

  • The company had committed, at that point on,

  • to take what their heritage was and invest

  • against the future spending internationally.

  • At that time-- let me go-- oh, I'm

  • going the wrong way-- at that time, as this shows here,

  • international markets were only half a million cases.

  • This was when I bought the shares.

  • Domestic was 3 and 1/2.

  • And they committed to growing that business abroad.

  • Now that meant nothing but years of burden

  • on the income statement.

  • Fast forward to today.

  • They have to almost 10 million cases internationally.

  • The US business came back because bourbon, for reasons

  • nobody knows, became popular.

  • So it grew.

  • But the international one is the deliberate result

  • of investment spending.

  • If you look down below, in 1987 they

  • had five markets that had over 50,000 cases, four

  • with over 100.

  • Today they have 41 markets with over 50.

  • The march towards 50 is very unprofitable.

  • You have all the fixed costs of a distribution network,

  • partnering, advertising, promotion.

  • You're not making a lot of money.

  • Over 50, you start to make a lot of money.

  • I think the next 10 million cases

  • will be much easier to get than the past 10 million cases.

  • During this time-- let me just take a look back here.

  • The business that I first invested in--

  • if you look down this list, it says

  • gross profit of $563 million.

  • Today they have $2 billion.

  • Operating capital 182 [INAUDIBLE] $971 million.

  • They dedicated themselves to doing nothing but growing

  • the business.

  • And they have the voting control of the family

  • that allow them to do it unflinchingly.

  • When they had left over cash, they

  • took it to buy back their shares, 360 down to 215.

  • And the EBITDA went from 200 to 1 billion.

  • And the share price went from $3.76 to today, it's $110.

  • And it's been about a 13% compound, which

  • is sort of what you can really aspire to in public equities,

  • in companies that don't have the kind of profile

  • that Google enjoys.

  • But this is a hand very well-played.

  • Family had a business that had integrity,

  • that had a culture that's extraordinarily

  • focused on making sure that nothing that they do

  • dishonors Jack Daniels, the heritage.

  • And they're willing to tell that story broadly

  • at the cost of current income to deliver

  • long-term wealth to the family.

  • And so I show it because it worked.

  • We have plenty that haven't worked,

  • just by the way, where the spending didn't

  • sort of yield results.

  • But one of the things you have to understand

  • is that I think businesses have to have that capacity

  • to suffer.

  • And it's true to say that investment managers have

  • to have the same capacity.

  • And so if you look at the history of my portfolio

  • returns, you'll see in 1999 we were down 2%.

  • The Dow was up 27, the S&P was up 21.

  • In the following three months, I think

  • that both of those indices were yet again up higher,

  • and I think I was 10% down first half of 2000,

  • and the NASDAQ was up another 50%.

  • I had to have the capacity for my investors

  • to allow me the right to underperform by 29 percentage

  • points if I was going to deliver the kind of returns

  • that we have, long term.

  • And if you look, as a result of being enabled to be out of step

  • for that period of time, we ended up

  • adding the most value ever in the subsequent three years

  • by not having the same declines that

  • consumed what looked like those early Internet

  • vapor returns that influenced the market.

  • I need to have the capacity be totally out of step

  • with the market if we're going to add value long term,

  • and that year was a good example.

  • Now this year I think I'm down 1% at the top,

  • and I think the Dow and the S&P are both down 8%.

  • So the markets have become quite volatile.

  • This is the portfolio.

  • The names should be kind of kind of familiar.

  • Berkshire, Nestle, MasterCard-- brilliant company-- Philip

  • Morris.

  • Most of them are international.

  • Most them are family-controlled.

  • And I think on that note, I'll just ask for questions.

  • AUDIENCE: I have several questions.

  • Maybe I'll give everyone a chance and come back.

  • THOMAS RUSSO: Let me take my tie off and settle in.

  • Fire away.

  • AUDIENCE: Easy questions.

  • One thing that stands out in your portfolio is MasterCard.

  • It's unlike the other holdings you have.

  • It's a strong consumer brand, not

  • a family-controlled business, very asset light.

  • I think if I look at the financials,

  • most of the cash flow convert into free cash flow.

  • Not that many opportunities to reinvest, but a long runway.

  • So kind of being different from all the other holdings,

  • would you maybe share your thoughts

  • on how you think about it, and the factors like this option

  • in the long run and things like that affect

  • MasterCard more than other things?

  • THOMAS RUSSO: Yep.

  • It's a great question.

  • It's a big holding.

  • It's really aligned to capture exactly the same forces

  • that I'm looking at in the consumer portfolio, which is

  • the rise of commerce globally.

  • And understand that, at the moment,

  • 85% of the global commerce is still cash.

  • And MasterCard set about to convert that.

  • And they have some partners in this process,

  • and they have the capacity to suffer along the way.

  • Not because it's family-controlled,

  • you're right.

  • But they somehow have gathered a group of investors,

  • including us, who have been willing to grant them the right

  • not to have operating leverage flatter their statements.

  • What happened is, when we first invested, the world collapsed,

  • the shares plunged in 2010 because of trouble

  • in domestic debit.

  • MasterCard's it's all about global credit.

  • But the domestic debit business changed after the Durbin Act,

  • Dodd-Frank, and the shares sold down to a modest level.

  • I met the management team, and the business is fine.

  • They're highly exposed to the growing and developing

  • markets, which I like.

  • It wasn't until Ajay Banga became CEO

  • that I bought my first share, having known him at Citibank.

  • He's an illustrious globalist, and has

  • the best Rolodex in the world.

  • And since he has to implement this business

  • through other partners, generally around the world,

  • he's a perfect person for the business.

  • He also had a capacity to understand

  • that his job was to deliver to his successor a much

  • stronger company.

  • That's his view.

  • And so every year since he's been at the helm,

  • the gross dollar volume of business,

  • pass-through of their business, is growing about 13% a year.

  • It's a very high fixed-cost business,

  • so all that advance suggests a higher margin.

  • You don't see it.

  • He's taking that incremental operating income that

  • arises from more volume over a fixed base

  • and reinvesting it regularly back into programs.

  • He has 55 projects that he started since he was there.

  • He hires, against your great demand, PhDs and millennials,

  • and he's changed the orientation of the company.

  • And so they poured back into the business investments

  • against the income statement that

  • keeps the income statement low, lower

  • than it would be if they just let those advances.

  • Now, the trick is, they have partners in this business.

  • They have partners in the form of governments.

  • And n Africa, for example, the government

  • wants payment systems because they

  • want to be able to disperse social benefits to the intended

  • beneficiaries without exposing them to the horrors of check

  • cashing locations, which are surrounded by casinos

  • and bordellos and people who are trying to steal their money.

  • Instead, they drop the money into biometrically activated

  • cards or phones as payment devices.

  • It's very efficient.

  • And it gets rid of all the frictions, 25%

  • to cash a check and all that stuff.

  • It's gone.

  • Other countries implement payment systems

  • because they want to enhance tax collection.

  • The Koreans understand that their people will not

  • declare taxes honestly, and so 93% of commerce in Korea,

  • by mandate, is being done through payment systems, not

  • cash.

  • They just don't trust their citizens.

  • And the way you get around that is

  • to have a taxable audit that's part of the MasterCard record.

  • And so we have all sorts of products

  • that are high technology payment systems using all sorts

  • of phones and other devices.

  • And there's just a general movement.

  • And since I'm oriented with the belief

  • that global commerce will grow, we

  • have 85% of that that's in cash we're going to convert,

  • a higher base over time.

  • So it's expensive.

  • It's gone up from $20 a share to $90 since I bought it in 2010.

  • So at $90 it's not as compellingly undervalued,

  • but I still think they have so much work ahead of them

  • that it's a worthy hold.

  • AUDIENCE: [INAUDIBLE], is the capacity to suffer evident

  • in the fact that MasterCard has significantly lower margins,

  • although very nice margins, than Visa's?

  • THOMAS RUSSO: But that's because they're investing so much.

  • AUDIENCE: So do you think that's why Visa--

  • THOMAS RUSSO: That's the measure.

  • AUDIENCE: So maybe the indication

  • is Visa is not investing as much?

  • OK.

  • THOMAS RUSSO: Yeah.

  • They have their own problems.

  • They have to buy Europe.

  • They don't even have the full global map yet.

  • And so they can't invest with certainty like MasterCard can,

  • because they know that if MasterCard comes up

  • with something, they can go around the globe just

  • like that.

  • They have to stop at the European gate and say,

  • can you do this?

  • They'll say no, yes, maybe.

  • So it's just not as harmonious.

  • And I do think that MasterCard is way outspending.

  • The history, at least now-- Visa has a new CEO,

  • and they're probably altogether much better at their game.

  • But that, historically, could explain the difference.

  • And I like that, I think, competitive position that you

  • see with that lower margin, because they're investing more.

  • AUDIENCE: Thank you.

  • Wonderful presentation.

  • THOMAS RUSSO: Thank you.

  • AUDIENCE: Thanks a lot.

  • I had a question about controlling the companies.

  • You said there's a family controlled factor

  • that comes into play, and that helps in basically

  • investing in the long term.

  • Do you feel it's exactly the same kind of control that comes

  • in with a tiered share class, where there are some classes

  • that have a higher [INAUDIBLE] than some--

  • THOMAS RUSSO: It's the same.

  • It's blocking.

  • It's the thing that allows you to say to someone

  • who would like to come along and ask you to change

  • your orientation, where the answer is no, we like it,

  • and you can't make us, however that's sourced.

  • Now there's a lot of hand-wringing over the fact

  • that super voting shares mean that you control without having

  • the economic interests aligned.

  • This is a company that set itself up that way.

  • It's a young, new company, and that was the terms

  • under which they embarked.

  • And I think it's healthy to have that kind of stability.

  • We'll see with time.

  • But I think it means that you guys, you people,

  • can all do exactly what it is that most inspires you,

  • and do so without regard to the possible hot breath

  • of an activist, because--I mean, think about how Yahoo is all

  • congested by virtue of people coming in insisting they do

  • this and this and that.

  • You really can't run a business in that context.

  • And you have the right to be free from that.

  • And it should allow you to surface things more

  • competitively.

  • Yes.

  • AUDIENCE: I was curious to hear if you think that there's

  • a place for value investing in technology companies,

  • because the nature of the industry is so dynamic.

  • I'm not sure if you're familiar with Clayton Christensen's

  • book, "The Innovator's Dilemma."

  • A lot of the-- in the cycle of maturity of tech companies,

  • they get to a point where they're almost like incumbents

  • defending market share and sort of investing

  • in financially viable investments, which

  • I guess, in the technology industry, sometimes

  • are not those which ultimately capture

  • the market in the long run.

  • So I know traditionally value investing

  • is reserved for more mature, predictable, slower moving

  • types of industries.

  • So I was just curious to hear your thoughts on that,

  • like whether the strength of a brands like Google or Uber

  • or something like that could help those companies persist

  • in spite of the dynamism.

  • THOMAS RUSSO: Yeah.

  • I think it's a great question.

  • I remember Clayton Christensen actually unleashed

  • the sort of excess of 1999.

  • Going back to that time, his book

  • was basically a battle cry for companies

  • to be willing to destroy themselves to succeed.

  • That was the whole idea.

  • And the beautiful image of it was

  • that you had CEO-to-CEO businesses, where

  • the old technology and everything that

  • ran the business made sense CEO to CEO, and down

  • to the very bottom of R and D, both

  • the customer and the technology company

  • recognized that the old ways were horrible.

  • But they could never get above-- they could ever implement it

  • because the top, who had to approve stuff,

  • was quite comfortable with the way that things worked.

  • And there would be an outside enterprise that would then

  • engage what they already knew in house, because it

  • was impossible to champion an in-house solution

  • against the kind of static top that the disruptions,

  • typically, that happened elsewhere--

  • but they didn't have to-- at research level, even in those

  • mature businesses.

  • The awareness was there.

  • It just couldn't get up, and that's culture.

  • And so ultimately, you've got to have a culture that's

  • willing, as it seems this one is, to source ideas broadly

  • and don't do so sort of command control from the top.

  • That at least gives you a shot, I think, at it,

  • because otherwise, the technology's so fast moving,

  • you'll quickly obsolete it unless you've got that culture.

  • This place may seem to have that, in which case

  • you've got the willingness to destroy what you relied upon

  • and move into other things.

  • AUDIENCE: You mentioned a lot in your discussion

  • about investing in companies that have demonstrated

  • the capacity to invest for the long haul,

  • and to suffer, and to really, like, make investments

  • where it hurts.

  • But the question that I come up with, especially regarding,

  • say, your Geico example, is how do you

  • distinguish companies that are actually

  • willing to make hard investments that are going to pay off

  • versus ones that are just chasing after things that

  • are actually to short-termism?

  • THOMAS RUSSO: You know, it's so interesting a question.

  • In fact, I have a slide that I rushed by,

  • and it says, you know, capacity to suffer is not enough.

  • And I had Barnes and Noble, and I had the Nook.

  • And you think, what?

  • Now Barnes and Noble's controlled by Riggio.

  • So he had control.

  • So he could do it.

  • But why would you ever want to go after you and Apple

  • on a laptop or a tablet or a book reader?

  • What possible stupidity was that?

  • Now mind you, along the way they had a $1 billion for Microsoft

  • and $600 million from Pearson.

  • So it wasn't their money.

  • But wow.

  • So it's got to be right.

  • And that's the trick.

  • That's the only thing that determines

  • our returns over time is-- for instance,

  • I had a huge position in newspapers going into 2000,

  • because I often think about a measure of whether I want

  • to invest in business is, how many dynastic fortunes do you

  • realize have been made from this business?

  • Well, there was no more dynastic source

  • of fortune than the newspaper business, historically.

  • Every city, the most prominent people in the city

  • owned the newspaper.

  • They controlled politics, money, and everything else.

  • And they had been able to survive

  • each generation of technology by incorporating

  • from print to radio, radio to TV, TV

  • to cable, cable to something else.

  • And then along comes the Internet,

  • and they say no, we don't want to share

  • our playground with you.

  • And it was the most unbelievable stupid moment

  • in the history of capitalism, because they

  • had learned over the years that to survive, they had to change.

  • They had to do exactly what Clayton Christensen said.

  • They had to be willing to kind of go

  • into these new technologies that threatened

  • through exclusive print revenue stream

  • for radio, and then for TV.

  • That was very Christensen-like.

  • And along comes eBay and Amazon, and they

  • say no, because they were both designed originally

  • to incorporate a newspaper platform.

  • No.

  • And that cost them dearly, because the air went out

  • of that balloon real fast.

  • And so it's not enough.

  • And it's not even necessary.

  • I just find it to be a place where

  • we have had some success, sort of thinking through what

  • it is that we want.

  • When we embark upon investing in businesses that we're

  • supposed to hold for a really long time,

  • I think these ingredients help keep

  • me focus on important and knowable factors.

  • MALE SPEAKER: With that, thank you

  • so much for a great presentation and wonderful conversations

  • with us.

  • Thank you.

  • THOMAS RUSSO: Pleasure.

MALE SPEAKER: Hello, and welcome everyone

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