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Graham & Doddsville

An investment newsletter from the students of Columbia Business School

Inside this issue: Issue XXXV Winter 2019

28th Annual
Graham & Dodd
Glenn Hubbard & Joseph Stiglitz Glenn Hubbard was named
dean of Columbia Business
Breakfast P. 3 School on July 1, 2004 and
has been a Columbia faculty
Glenn Hubbard & member since 1988.
Joseph Stiglitz P. 5
Student He received his B.A. and
Investment Ideas P. 13 B.S. degrees summa cum
laude from the University of
Jeff Mueller ’13 & Central Florida. He also
Damon Ficklin P. 17 holds AM and PhD degrees
in economics from Harvard
Dov Gertzulin P. 26 University.

In addition to writing more


(Continued on page 5)

Editors:
Ryder Cleary Polen Capital
MBA 2019
Damon Ficklin joined Florida-based Polen
Gregory Roberson, Esq. Capital in 2003, where he is the Lead
MBA 2019 Portfolio Manager of the Global Growth
David Zheng Portfolio and Co-Portfolio Manager of the
MBA 2019 Focus Growth Portfolio. Prior to joining
Polen, Mr. Ficklin was an Equity Analyst
Frederic Dreyfuss with Morningstar and a tax accountant with
MBA 2020 PwC. Mr. Ficklin earned a B.S. in
Sophie Song, CFA Accounting from the University of South
Florida, an M.S. in Accounting from
MBA 2020
Appalachian State University, and an
John Szramiak M.B.A. with High Honors from The
MBA 2020 Damon Ficklin & Jeff Mueller ’13 (Continued on page 17)

DG Capital Management
Visit us at:
www.grahamanddodd.com Rolf in
Prior to forming DG Capital Heitmeyer
2007, Dov Gertzulin was a
www.csima.info Portfolio Manager at Neuberger Berman where he
specialized in value-based and event‐driven situations, co‐
managing over $4 billion for high net worth and institutional
investors. Before joining Neuberger Berman, he was a
research analyst at JDS Capital Management. Mr. Gertzulin
received his M.B.A. with distinction from New York
University’s Stern School of Business, where he specialized in
finance and accounting and was named a Stern Scholar. He
earned a B.B.A. from Baruch College, graduating summa
(Continued on page 26)
Dov Gertzulin
Page 2

Welcome to Graham & Doddsville


We are pleased to bring you and Damon discuss their in- (TRVW).
the 35th edition of Graham & vestment guardrails, managing
Doddsville. This student-led risk with quality, geographic We continue to bring you
investment publication of Co- diversification, and the chang- stock pitches from current
lumbia Business School (CBS) ing consumer landscape in students at CBS. In this issue,
is co-sponsored by the Heil- China. They also discuss indi- we feature a pitch from the
brunn Center for Graham & vidual positions in Tencent 2018 Women In Investing
Dodd Investing and the Co- (TCEHY), Alibaba (BABA), Conference, where Tonya
lumbia Student Investment Adobe (ADBE), Starbucks Kostrinsky ’20, Stephanie
Management Association (SBUX), and Align Technolo- Moroney ’20, Vivian Wang
Meredith Trivedi, Managing (CSIMA). Since our Fall 2018 gy (ALGN). ’20, and Freda Zhuo ’20
Director of the Heilbrunn issue, the Heilbrunn Center pitched Nordstrom (JWN)
Center. Meredith skillfully hosted the 28th annual Gra- Lastly, we interviewed Dov long. We are also happy to
leads the Center, cultivating ham and Dodd Breakfast. Gertzulin, founder of DG present the winning pitch of
strong relationships with Capital, a value-focused in- the 2018 CSIMA Stock Pitch
some of the world’s most Our first interview is with two vestment firm that specializes Challenge, a long thesis on
experienced value investors former Chairmen of the Presi- in middle market opportuni- Lions Gate Entertainment
and creating numerous dent’s Council of Economic ties across the capital struc- (LGF) from Amit Bushan ’20,
learning opportunities for Advisors: our very own dean ture. DG Capital’s focus on Bruce Kim ’20, and Stephanie
students interested in value Glenn Hubbard and Nobel distressed securities, post- Moroney ’20.
investing. Laureate Joseph Stiglitz. In reorganization equities, and
the interview, we discuss index other special situations pro- We thank our interviewees
funds and the future of asset vided great perspective as we for contributing their time
management, Jerome Powell’s approach 10 years of a post- and insights not only to us,
job thus far as Fed Chairman, Great Financial Crisis bull but to the investment com-
areas of risk and fragility in the market. Dov discussed his munity as a whole.
economy, and the possibility of early years in the industry
secular stagnation in the Unit- during the mania of the tech - G&Dsville Editors
ed States. bubble, the importance of
catalysts in an investment
We also sat down with Jeff thesis, and investing in dis-
Mueller ’13 and Damon tressed debt during the finan-
Professor Tano Santos, the Ficklin, portfolio managers of cial crisis. He also discussed
Faculty Director of the Heil- Polen Capital’s Global Growth individual positions in Contu-
brunn Center. The Center
Portfolio, which is a concen- ra Energy (CTRA), Tropicana
sponsors the Value Investing
trated growth fund with a Entertainment (TPCA), and
Program, a rigorous aca-
demic curriculum for partic-
global investment mandate. Jeff Twin River Worldwide
ularly committed students
that is taught by some of the
industry’s best practitioners.
The classes sponsored by
the Heilbrunn Center are
among the most heavily
demanded and highly rated
classes at Columbia Business
School.

Snapshot of the audience at the 28th Meredith Trivedi with Professor Tano
Annual Graham & Dodd Breakfast Santos, Faculty Director of the Heilbrunn
Center for Graham and Dodd Investing.
Volume I, Issue
Page 23 Page 3

28th Annual Graham & Dodd Breakfast

Presenters John Griffin and Ian McKinnon share a laugh Thomas Russo and Andrew Gundlach ’01 catch up during
a break

John Griffin and Professor Michael Mauboussin have a Professor Tano Santos listens intently to the event’s
conversation proceedings

CBS professors Daniel Krueger ’02 and Yen Liow join a


packed house for discussions on value investing
Page 4

SAVE THE DATE


The Heilbrunn Center for Graham & Dodd Investing at
Columbia Business School presents

THE 10TH ANNUAL

From Graham to Buffett and Beyond


OMAHA DINNER

Friday, May 3, 2019


6 p.m. to 9 p.m.

The Hilton Omaha


1001 Cass Street
Omaha, Nebraska

Tickets go on sale in March at


www.grahamanddodd.com

The annual From Graham to Buffett and Beyond event is generously sponsored by:
Page 5

Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz


(Continued from page 1)

than 100 scholarly articles the Chief Economist of the funds could, in theory, be anti-
in economics and finance, Roosevelt Institute. A competitive. He writes that
he is the author of three recipient of the Nobel “the premises of the theory –
popular textbooks, as well Memorial Prize in that managers are responsive
as co-author of The Aid Economic Sciences (2001) to shareholders, that
Trap: Hard Truths About and the John Bates Clark shareholders are increasingly
Ending Poverty, Balance: Medal (1979), he is a diversified, and that the joint
The Economics of Great former senior vice interests of companies in an
Powers From Ancient Rome president and chief industry can conflict with the
to Modern America, and economist of the World interests of consumers – ‘all
Glenn Hubbard
Healthy, Wealthy, and Wise: Bank and a former seem, not just reasonable, but
Five Steps to a Better Health member and chairman of like basic textbook stuff’.”
Care System. His the (US president's) Martin Schmalz, a finance
commentaries appear in Council of Economic professor at Oxford and a
Business Week, the Wall Advisers. In 2000, he leading proponent of the
Street Journal, the New York founded the Initiative for theory, asks, “Is there any
Times, the Financial Times, Policy Dialogue, a think plausible story for why these
the Washington Post, tank on international secular changes in the
Nikkei, and the Daily development based at ownership structure of firms
Yomiuri, as well as on Columbia University. He would not lead to a lessening of
television and radio. has been a member of the competition?” So, should index
Columbia faculty since funds be illegal?
In government, he served 2001 and received that
as deputy assistant university's highest Glenn Hubbard (GH): That
secretary for tax policy at academic rank (university is absolutely silly. Full
Joseph Stiglitz the U.S. Treasury professor) in 2003. In 2011 disclosure: I am a Director of
Department from 1991 to Stiglitz was named the BlackRock Fixed Income
1993. From February 2001 by Time magazine as one Funds, and BlackRock definitely
until March 2003, he was of the 100 most influential has a point of view on this
chairman of the U.S. people in the world. subject. It is crazy to imagine
Council of Economic Known for his pioneering that the existence of large
Advisers under President work on asymmetric passive investors like index
George W. Bush. In the information, Stiglitz's work funds and ETFs is facilitating
corporate sector, he is a focuses on income anti-competitive behavior.
director of ADP, distribution, risk,
BlackRock Fixed Income corporate governance, BlackRock or Vanguard or
Funds, and MetLife. public policy, State Street own X% of every
Hubbard is co-chair of the macroeconomics and large-cap company. Take the
Committee on Capital globalization. He is the example that critics of
Markets Regulation; he is a author of numerous books, common ownership use: the
past Chair of the Economic and several bestsellers. His airline industry. The same
Club of New York and a most recent titles people who own X% of the
past co-chair of the Study are Globalization and Its airlines also own hotels and
Group on Corporate Discontents Revisited, The everything else, so trying to
Boards. Euro, Rewriting the Rules of monopolize the airlines would
the American hurt them elsewhere. And
Joseph E. Stiglitz is an Economy and The Great there is just no evidence of this
American economist and a Divide. actually happening.
professor at Columbia
University. He is also the Graham & Doddsville The bigger question surrounds
co-chair of the High-Level (G&D): Bloomberg’s Matt how you would get discipline
Expert Group on the Levine sometimes writes about on companies if all investment
Measurement of Economic the idea that common were passive. That’s a more
Performance and Social ownership of firms in the same interesting question. If all
Progress at the OECD, and industry through passive index investment were truly passive,
(Continued on page 6)
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Harvey Sawikin
Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz
it would be hard to have JS: He didn’t make a lot of other side of that argument.
corporate control. You always money out of it.
need a strong, active market G&D: The trade war is top of
for corporate control. I think GH: By my standards he did! mind for a lot of investors
there will always be a need for Fortunately, Columbia Business right now. What is the political
active investors to help solve School is blessed to have some rhetoric getting right and what
agency problems in corporate non-ordinary investors as is it getting wrong?
governance, whether that’s a donors, otherwise we
large fund, a rich person, or a wouldn’t be building JS: Well, the focus is on the
private equity organization. Manhattanville. But most bilateral trade deficit – I don’t
people aren’t those star think you can get any
Joseph Stiglitz (JS): The investors. Index funds are, in economist to say that makes
reason index funds became so my opinion, the right sense.
popular was that they were investment vehicle for most
doing a better job managing investors. If you ban them, GH: Except Peter Navarro.
funds for ordinary investors, how are average people better
net of fees and transaction JS: Yes, except Peter Navarro.
costs. The one caveat I would You’re not even an economist
add to what Glenn said is, as “Index funds are, in my if you say that, almost by
more of the stock market is definition. Whether you
owned by passive funds, opinion, the right believe in free trade or not,
assuming they’re really passive bilateral trade deficits are not
investment vehicle for
and do not exercise any what matters. Trade
control, that means that you most investors. If you agreements don’t determine
can get control of a firm with a the multi-lateral trade deficit.
lot less capital. If you had a ban them, how are That’s determined mostly by
company that’s worth $10 macro.
billion and is 95%-owned by average people better
index funds, then you can get GH: Meaning the financial
control with $500 million. So off as a result?” gains and the opportunity for
you lower the threshold for investment and savings.
getting de facto control. It off as a result? They would be
becomes an empirical question. thrown back into a world JS: Trade agreements, i.e.
I haven’t seen that as a major where fees are relatively high what you import from which
problem, but I haven’t really and performance is relatively country, affect standards of
been following it. low. That doesn’t strike me as living but don’t affect the
a good idea. macroeconomy. As
GH: On the competition macroeconomists, if there is an
point, what are the policy JS: I think the real issue is the unemployment problem you
implications of banning index danger that someone could get use macroeconomic tools:
funds? For the average person, control of a firm with relatively monetary and fiscal policy. If
index funds are the low-cost, little money. But with regards they’re not working,
efficient way to invest. to index funds reducing something’s wrong.
competition between firms,
JS: What Vanguard has done there has been some literature Some discussions on China are
has just been amazing. recently on cross-ownership. obscured by the fact that there
is a very big difference
GH: It’s ironic for me to see GH: Yes, and I don’t buy it. between value-added
these arguments and then production and gross
simultaneously see Jack Bogle JS: I’ve been very skeptical. I production. A lot of what we
being rightly lionized after he just don’t see the mechanism import from China is stuff that
passed away, because he truly for it. is not Chinese. Probably 90%
made enormous contributions of the iPhone is not made in
to the welfare of society at GH: You’ll be seeing some China. The value added in
large. papers coming out on the China is 10%. But when we
(Continued on page 7)
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Harvey Sawikin
Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz
talk about imports, we treat it so deep into GMO that if they tackle China you go after the
as a $1,000 phone imported. In restrict GMO, we can't export fact that China made promises
the case of China, the many of our agricultural it did not keep. I was one of
confusion between the gross commodities. the people who pushed hard
numbers and the value-added for China to go into the WTO,
numbers is a big deal. Where this is coming up now but China made promises it
is in privacy, secrecy, AI, big has not kept. Thus, I think
That in turn relates to some of data – and I think I'm more on there’s a real reason to
the confusion about what is at the European side of those challenge China in the WTO.
stake. The things that we issues. Privacy and the norms But if President Trump wants
export to China are by-and- around cyber security are to do that, he shouldn’t
large much closer to 100% really important. But there are simultaneously attack the EU,
value-added. When we export still huge benefits from trade. Japan, and Canada.
soybeans, 100% of the The question is: what are the
soybeans are made in America. appropriate rules for getting JS: When he says that steel
When you account for the those gains from trade on and autos are national security
difference in value-added trade, something that might be called issues, he loses credibility.
it significantly changes the a roughly level playing field?
numbers and the trade deficit GH: I’m not sure I would want
appears much smaller. GH: I think that’s one of the to live in 1955, but even if I
reasons we’re struggling with did, it’s not on offer. We
And finally, I think there is a the trade discussions, even shouldn’t be telling the public
broad issue that has come to though everything you learned we can make it 1955 again,
the fore. It has always been in freshman economics is still because we can’t. What we
with us, and we have never true. Free trade is a good need to be doing is helping
been able to face up to it. And thing. But, the thing we always people prosper in 2019, or
that is managing trade with say under our breath, as 2055. I think that’s the bigger
countries that have different economists, is that the gainers issue surrounding trade. The
value systems and different will compensate the losers. ugliness on the trade issue has
regulatory systems. We see it Well, we’re not doing that, and to do with a lot of people
in the controversy between it’s a shame that elites around feeling left behind. Nobody lied
the U.S. and Europe on GMO. the industrial world are telling to them. Trade does generate
Europe says it cares about average people they should prosperity, it just doesn’t
GMO, while many Americans just suck it up because we’re generate it for everyone.
think it is just superstition. But going to be better off
if Europeans really do worry collectively. We are better off JS: Economic theory predicted
about it, and it affects their collectively, but not every person there would be losers from
utility, their view is they should is better off. trade.
have the right to regulate it.
JS: It could even be the GH: Right, but if the surplus is
We view GMO as a trade majority of Americans are large enough you can
barrier. Even transparency is worse off. compensate them so that
an issue. If Europe passes a law collectively we are all better
saying that you have to GH: Yes. The majority could off. But that hasn’t happened.
disclose GMO, then Europeans be worse off and measured
won’t buy American wheat, GDP could still rise. I think this JS: Another aspect of the
and we view that as a trade problem is a big one. The trade dispute is that we
barrier. That has been a source other issue is China. China is a haven’t distinguished areas
of contention between the U.S. bad actor in international with international rules from
and Europe for a long time. trade. I think the President areas without international
That's a narrow area, but you rightly called them out. But his rules, and this undermines the
can see how two differing problem is that of the dog credibility of our contentions.
societies with different values chasing the car. What are you For instance, there is no
come into tension over the going to do when you catch it? international investment
right legal framework. We are To me, if you really want to agreement. There could have
(Continued on page 8)
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Harvey Sawikin
Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz
been one, but I think the U.S. unite your allies and divide When I saw Jay in meetings of
overreached. China’s view on your enemies, but we seem to the American Economic
joint ventures is that everyone be doing the opposite. Association, he was very good
who came into China knew the at calming people down, and
rules of the game. You might this is a time when both
say the rules aren’t fair, but “I was one of the Democrats and Republicans
there’s no international have their knives out for the
agreement saying you can’t do people who pushed Fed. Someone like Jay has
what they’ve done. hard for China to go exactly the right integrity and
personality for the job.
GH: They forced technology into the WTO, but
transfer, and that’s against the I think he has made some
WTO protocol. But they say China made promises missteps in communication,
they’re not really forcing it. and that has contributed to
it has not kept. Thus, I market volatility. One is clearly
JS: They’re not forcing it. about the size of the balance
Companies knew the terms. think there is a real sheet. If you want to reassure
China’s view is that there’s no reason to challenge markets, you need a theory of
investment agreement saying how big a balance sheet you
that you can’t require joint China in the WTO.” need. Sometimes The Wall
ventures. There could have Street Journal editorial page
been, but it wasn’t negotiated writes as if we are going to go
and therefore they had the JS: To increase your credibility back to the pre-crisis balance
right to do it. and acquire allies, you use sheet, but that’s an era when
international laws. And there is the federal funds rate was
But there was an agreement a WTO forum for trade determined in the market for
on cyber security with the disputes. reserves, and reserves had a
Obama administration. All the positive shadow price.
evidence is classified so we GH: Which, by the way, we
can’t fully know, but everyone win much more often than we That isn’t the world we live in
who looks at it says they lose. today. We now have foreign
violated the Obama corridor systems, large balance
agreement. That is a situation JS: Almost always. We win sheets, lots of excess reserves,
where I think they should most of the cases. and interest on excess
more clearly define the rules in reserves. I think it’s naïve to
international or bilateral GH: If you say, “The WTO is think the balance sheet will be
agreements. But we’re losing in our way,” that is not true. small. If the Fed were to say,
credibility by mixing “national “Okay, here’s where we think
security and steel” arguments JS: If Glenn and I brought a the balance sheet will be, and
(which are not credible) with case to the WTO and they here’s our path to get there,” I
arguments where there are agreed with Glenn rather than think that would be much
genuine concerns. me, I’d say, “That's the law.” more reassuring to markets
I’m very impressed with the than saying “We’re data-
GH: I’ve been on the U.S.- quality of the judges at the dependent,” whatever that
China Economic and Security WTO. means. I give them some good
Commission for the past few marks, but I think there's some
years. If you look at our G&D: How is Jerome Powell work to do.
reports, you will see that we doing as Fed Chairman?
hold hearings on all of these JS: Besides the messaging, I’m
issues. The U.S. has blown its GH: He is a good pick for that actually sympathetic to the
opportunity to lead a big job in some sense because of Fed’s open-mindedness
WTO challenge of China politics, and I mean that with a because, just to reflect what
because we don’t have any small “p”. I don’t mean that he Glenn said, we’re in a new
allies. It makes it hard. I always is political. I mean he is very world now. There’s no a priori
thought you were supposed to good at “small p politics.” right size for the balance sheet.
(Continued on page 9)
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Harvey Sawikin
Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz
There’s no theory that dictates repaid, and then if you make the London School of
that… large misjudgments and people Economics, she asked
don’t get repaid, that has big economists like Joe and me,
GH: Right, so you say, “Here effects throughout the “Why did nobody see it
is how I, the leader, am economy. coming?” And the answer to
thinking about it.” her question was that nobody
I worry there are places where was talking to each other. So-
JS: I think I would have been lending has gotten displaced called experts weren't talking
inclined to say what he said, out of our banking system. We to practitioners. That has not
because I don’t know what the have figured out how to gotten any better. I don’t think
right answer is either. That’s control the banking system a the Fed is aware of all the
not good messaging; I wouldn’t little better, but that leads to financial innovations actually
be a good Fed Chairman. But non-bank lending that may not happening in the country. And
what he said is an honest be monitored as closely. I don’t know that all the
reflection of our current state finance academics are either. I
of ignorance. But it also may GH: I would agree. Financial remain very worried. Everyone
be far less important than a lot crises require leverage. If you says we’re safe now. I don’t
of people in the market look at the tech bubble think so.
believe. My general view is that collapse in the early 2000s, the
it is probably large changes economy barely hiccupped And the politics of it are so
that matter - and expectations because the collapse was all wicked. I will go to my grave
of large changes - more than about a decline in just equity believing that one of the
the level. value – some tech investors reasons we see populism today
lost a lot of money, but the is that during the financial crisis
GH: Also, many fingers are economy as a whole was fine. we bailed out the banks and
now pointing at the Fed with The financial crisis involved a failed to assist homeowners
how the balance sheet rolls off, lot of largely implicit debt that who could not refinance their
but a nearly trillion dollar people didn’t even realize was mortgages. That pain and that
annual budget deficit has a debt but was effectively debt memory will last a generation.
much bigger effect on the through securitization and I worry that if it happens again,
supply of Treasuries. Politicians tranching. And I worry about we’ll be in trouble.
should stop and say, “Wait a shadow banking for all the
minute, where did all those reasons Joe said. Shadow JS: I totally agree with Glenn.
Treasuries come from? From banking was a core problem of That was a really bad mistake
us, not the Fed.” the financial crisis, and it’s still on the part of Obama.
here. In many cases, it is worse
G&D: Which sector of the and harder to find now G&D: Should practitioners be
economy do you think will because we have doubled paying more attention to
cause the next crisis? down so much on bank academic research?
regulation.
JS: Some part of the financial GH: The most successful
sector. I think that's where the JS: Banks have lent money to investors I’ve known are
fragility is in our economy for firms that are engaged in actually pretty close to
the most part. There are many shadow banking, so we haven’t research, and they enjoy it
parts of the economy where done a great job at regulating because they can dig up
there is a lot of leverage. Debt what you might call “indirect opportunities that others
is different from equity in a lending.” If payday lending might not see. Most successful
fundamental way – you have increases, who finances the investors I know listen a lot,
promises to repay which you payday lenders? The banks and they don't talk much. I
will or will not fulfill. With might. often get people asking me for
equity there’s no promise, so opinions and I say, “What do
you go up and down. It’s more GH: I worry that we haven’t you think? You’re a billionaire.
of a continuous variable. But learned the lesson from the I’m going to learn more from
with debt you lend out money Queen of England's question you!” But they don’t say
with the hope of getting after the last financial crisis. At anything.
(Continued on page 10)
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Harvey Sawikin
Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz
variables can have big effects. Brexit. It’s not just what
These investors go to me, to Whether we can grow GDP at happens between Britain and
Joe, and to a hundred other 1.8% or 2.8% over the long run the EU, but what it means
economists and synthesize the is important – changes in views generally: are elites capable of
information like a honey bee on that question can move selling average people on the
going to different flowers. markets dramatically, and benefits of the EU?
People say investing is not policy uncertainty amplifies
Bruce Kim ’20, Amit academic, but it’s very JS: The recent market
that.
Bushan ’20, and Stephanie
academic. And it’s not just volatility is not the result of a
Moroney ’20 pose after
their winning CSIMA Com-
financial research, it’s also With regards to Brexit, there major change in the functioning
economic research. has been just an extreme lack of the financial markets. It’s
petition pitch.
of competence. Putting your not like high-frequency trading
I think Warren Buffett spends country up on a 51/49 vote is was just invented. By the way, I
his time productively figuring unwise, and it has been do think high-frequency trading
out market structure questions negotiated terribly since then. adds to volatility and is not
and what I would call industrial Having said that, the necessarily a socially
organization questions. I’m not frustration that led to Brexit is productive activity, but it’s not
sure he’s as interested in the same sort of populism we the driving force behind the
finance as much as he is already discussed. There are increase in volatility we’ve seen
interested in economic people who point their fingers recently. I think it is exactly
intuition. The most successful at the Leave voters saying, what Glenn said: we’re
investors I know talk to a lot “They’re stupid, they didn’t entering a world in which
of people in the business: not understand it.” I don’t think so. there is more uncertainty
just in the company in which I think they very well surrounding the parameters of
they’re interested but to understood the implications. the economy, i.e. what is the
people in the industry as well. growth rate, etc. In a more
normal world, the broad
“If the Fed were to say,
JS: Market structure is consensus would be that the
important because in ‘Okay, here’s where we economy is going to grow at
competitive markets, profits population plus productivity.
are going to be competed think the balance sheet Productivity could grow at
away quickly. That’s why maybe 1.4-1.6%, but volatility
Warren Buffett always talks will be, and here’s our in productivity is very small. In
about building moats and a normal world there would be
making them wider. Lots of path to get there,’ I a more broadly accepted
people would like to cross consensus about the
think that would be
those moats. There is a underlying parameters of the
tension here between what’s much more reassuring economy.
good for the economy and
what's good for the firm, but to markets than saying Yet, recent policy uncertainty
Buffett has a very intuitive has introduced a lot of
sense of where there are ‘We’re data- uncertainty about medium and
sustained profits. long-term growth rates. If
dependent,’ whatever anybody takes seriously what
G&D: Can we get your views that means.” Trump says, and some people
on the causes of recent market do, he says we can grow at 3-
volatility, as well as your 4%. To me that’s a fantasy, but
thoughts on Brexit? And I think they very well I think some people believe it
understood that the country because they’re not
GH: The recent market might on average be worse off decomposing the recent
volatility is a result of both under Brexit, but they felt they growth rate into the impact of
perceptions of Fed policy as weren’t getting their fair share a fiscal shock and the true long
well as overall policy and they didn’t like the control -term growth rate. When you
uncertainty. Also, small issues with the EU. And I think have a big increase in the
movements in a few important that’s really the wild card of deficit, that will grow the
(Continued on page 11)
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Harvey Sawikin
Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz
economy faster than the (GPT), and if you look at and through immigration. So
underlying fundamentals. previous GPTs, it takes a long that’s less of a good news
Saying, “Oh, we just grew at time to see the full effects. I story. But if we’re talking
3.5%, we’re in a new world” is mean, Bob Solow’s famous about productivity, I’m pretty
really stupid. But some people quote “You see productivity optimistic.
out there want to believe that, everywhere except for in the
and so we’ve seen a lot of productivity statistics” was JS: There are two parts to
uncertainty in the underlying uttered just before you could secular stagnation. One is the
parameters of the economy see it in the productivity short-run component, which
that we didn't used to see. We statistics. you might call “macro
had similar uncertainty back in management,” and the other is
’08-’09, but we haven’t had it Part of the problem is not that the long-run component,
for a while. scientific progress takes a long which depends on the rate of
time, but that it takes a long technological change. And we
G&D: Will the uncertainty time to change the way firms can never perfectly know
continue for as long as Trump are organized. Whether you’re about the long-run component
is President? considering electrification or until we experience it. I am
the internal combustion engine mostly a techno-optimist with
JS: The policy uncertainty will or mainframe computing, regards to productivity and
continue. It could even get previous GPTs took a long artificial intelligence. I am a
worse. Remember we’re not time to become incorporated little more pessimistic about
only talking about economic into the economy. I believe we the way we manage our
policy, we’re talking about war workforce, with a fraction of
– a President announcing the American population
foreign policy perspectives that “Most successful either addicted to opioids or
are counter to what the not well-trained, and with our
investors I know listen a
foreign policy establishment average exam scores low
says. These are not minor lot, and they don’t talk relative to peers. There are
issues. There are people two countervailing forces: our
betting that within X months much. I often get human capital is not doing well,
we’ll have a war in the Middle but our technology is doing
East. people asking me for really well. How those will
balance out, no one knows.
G&D: What are your views opinions and I say,
on secular stagnation, and GH: The silver lining is that
‘What do you think?
what are the implications for some of those things are
asset managers? You’re a billionaire. I’m fixable. Turning around
demography is hard, but
GH: I don’t believe in it. going to learn more achieving an adequate
healthcare system and treating
JS: I don’t either. from you!’ But they the sociological pathologies
that lead to alcoholism and
GH: Yet, it is definitely don’t say anything.” drug abuse – these are
important for asset managers problems we can actually
to consider this question. are going to see a productivity address. The politics are
Permanently low levels of real transformation. We are not admittedly difficult.
interest rates would affect the going to see the same
rate of return on all assets. But favorable tailwind from the JS: I think there is a bit of a
I’m not so pessimistic about labor market because right macro problem, and that is the
long-run productivity growth. now our society is both aging increase in inequality combined
The way I see it, artificial and not favorably disposed with lower marginal
intelligence and machine toward immigration, and the propensities to consume at the
learning have all the attributes way you bolster your hours top than at the bottom. The
of what economists would call worked is through native massive change in the
a General Purpose Technology demographic improvements distribution of income has
(Continued on page 12)
Page 12

Dean Glenn Hubbard and Nobel Laureate Joseph Stiglitz


macro consequences. And we
know how to deal with that.
There are clear needs for new
infrastructure and labor force
training. I think there is wide
agreement over how to
technically solve these
problems. We just do not have
the political will to solve it.

G&D: Do you have any advice


for MBA students going into
investment management?

JS: Buy low, sell high. Be


smarter than everybody else.

G&D: Brilliant!

JS: My serious advice would be


to think about market
structure – not just good
ideas, but market structure. In
a sense, economists would call
it arbitrage. Intellectual
arbitrage. Take something that
has worked in one place and
try it somewhere else. If you
can be the first person in, you
get something out of it. Many
of our advances are in one way
or another intellectual
arbitrage.

GH: I agree. The successful


evaluation of entrepreneurial
opportunities is all about
putting a puzzle together in a
way nobody else saw. To me
that is also the secret to great
investing. My other admonition
to you is Biblical: To whom
much is given, much will be
required. You all need to care
about the welfare of society,
and we are depending on you.

G&D: Thank you for your


time.
Page 13

Nordstrom, Inc. (NYSE: JWN) - Long


2018 Women In Investing (WIN) Conference
Tanya Kostrinsky Stephanie Moroney Miaozi (Vivian) Wang Freda Zhuo
TKostrinsky20@gsb.columbia.edu SMoroney20@gsb.columbia.edu MWang20@gsb.columbia.edu FZhuo20@gsb.columbia.edu

Trading Statistics (as of 11/12/2018)


Capital Structure Key Statistics
Tanya Kostrinsky ’20 Share Price
Tanya is a 1st year student at (11/12/2018) $64.30 52 Week High $67.75
CBS. Prior to CBS, Tanya was an Shares (M) 168.6 52 Week Low $38.39
equity research analyst at Fine Market Cap ($M) $10,860 EV/LTM EBITDA 7.8x
Capital, a value-oriented long/
- Cash $1,343 Target EV/EBITDA 9.7x
short hedge fund.
+ Debt $2,734 Target Price $94.00
Ent. Value ($M) $12,416 Return 46%

Recommendation
We are long Nordstrom (JWN) with a price target of $94, representing 46%
upside on 11/12/2018’s price of $64.30. Despite common perception,
Nordstrom is not only a traditional department store, but it also generates
>50% of its revenue from e-commerce and Nordstrom Rack. Continued
outperformance in these favorable pockets of retail industry will support
growth in cash flows and a valuation re-rating.
Business Description
Founded as a shoe retailer in 1901, Nordstrom is a leading fashion retailer in
Stephanie Moroney ’20 the U.S. today, offering a selection of high-quality brand-name and private
Stephanie is a 1st year student at label merchandise. Nordstrom provides customers with a differentiated,
CBS. Prior to CBS, Stephanie seamless shopping experience through multiple retail channels. 45% of sales
was an equity research analyst at
Anchor Capital Advisors, a value come from Nordstrom full-line stores, 26% from Nordstrom Rack, and 25%
focused investment firm. from the full-line and off-price online businesses. Nordstrom’s footprint
spreads across the U.S., with a high concentration on the West Coast. The
Nordstrom family owns ~30% of the company and manages the company as the CEO.
Investment Thesis
1) E-commerce capabilities prove Nordstrom is not a traditional retailer anymore
JWN began investing in its digital capabilities earlier than its competitors, with investment growing at a 20%
CAGR 2010-2015. It now boasts the highest exposure to online growth among its department stores peers at
26% of sales today, with expectations to reach 40% of sales by 2020. In-store and online purchases have simi-
lar margin profiles, inclusive of returns. Typically in retail, 80% of off-price online orders are returned in-store
and over 60% of full-price online orders are returned in-store. JWN, however, managed to mitigate the dilu-
tive impact of reverse logistics on retailer margins.
Miaozi (Vivian) Wang ’20 Part of JWN’s investment in e-commerce has included initiatives to improve fulfillment of online orders and to
Vivian is a 1st year student at get items to the customer as quickly as possible. Online orders are shipped primarily from two owned fulfill-
CBS. Prior to CBS, Vivian was a ment centers (Cedar Rapids, IA and Elizabethtown, PA) as well as from a leased fulfillment center in San Ber-
sell-side equity research analyst
at China International Capital
nardino, CA. Owning two of its centers is especially advantageous as JWN has more direct control of its
Corporation covering the online fulfillment operations, which had allowed JWN to learn how to manage the fulfillment process more
energy sector. efficiently. JWN built these centers nearly a decade ago as their e-commerce business was picking up; replicat-
ing the same logistics network today would be significantly more expensive. In addition, the recent efforts to
move from a push-inventory model to a pull-inventory model allows for leaner inventory management and
frees up additional dollars in net working capital. These important improvements to supply chain operations
make it possible for customers to get their purchases quickly and mitigate the risk of losing customers to
competitors due to speed and cost of delivery.
Finally, JWN recently rolled out its local store strategy in LA. The local store in LA will serve omnichannel
customers and will not carry inventory actively. Instead, JWN is adding several fulfillment centers near LA
which will allow customers to place online orders for faster pickup at the physical store, which will offer an
array of services, including alterations and stylist appointments. Given how concentrated JWN’s sales are (LA
and NYC make up 25% of JWN sales), JWN believes that this strategy will increase fulfillment times and marry
Freda Zhuo ’20 the best of the online and in-store experiences to further engage and retain customers.
Freda is a 1st year student at
CBS. Prior to CBS, Freda was a
sell-side equity research analyst
at Goldman Sachs covering
**Editor’s note: JWN was originally presented in November 2018 at a share price of $64.30 with
consumer staples companies.
a target of $94, representing 46% upside**
Page 14

Nordstrom, Inc. (JWN) - Long (Continued from previous page)


2) Attractive retail trends and long runway underpin growth of Nordstrom Rack
Nordstrom Rack sells high end brands at 30-70% discounts. It provides a unique treasure hunt-like shopping experience, similar to TJ
Maxx and Ross but with a broader assortment of high-end brands. The Rack generates $5bn in sales annually and has been growing sales
and market share by 13% and 26% respectively since 2012.
Nordstrom trades at a six-turn valuation discount to TJX and ROST, despite its better performance and growth opportunities in the off-
price segment. Nordstrom Rack has grown same-store sales at a 4.4% rate over the last five years versus 3.5% at TJX and ROST. In addi-
tion, Nordstrom Rack’s store productivity is better at $500 sales per square foot versus $400 at its off-price peers. Finally, the Rack has a
long growth runway, with just 250 stores versus TJ Maxx and Ross with over 1,500 each. With sustained growth in same-store sales and
new store openings, we expect Nordstrom Rack to be a driver for performance and valuation closer to Nordstrom’s off-price peers.
3) Strong cash generation provides extra upside potential
The stock is currently trading at a 9% free cash flow yield. We believe the completion of capital-intensive e-commerce investments and
growth from Nordstrom Rack will support positive growth in JWN’s cash flows. Moreover, Nordstrom’s outstanding track record of
disciplined and effective capital allocation could reinforce the company’s strong commitment to shareholder returns. The seasoned man-
agement team led by the Nordstrom family has prudently spread capex over many years and capped annual capex at 5-7% topline even
during the investment cycle. This stable pace of investment also supports Nordstrom’s market-leading ROIC. Meanwhile, Nordstrom
generates free cash flow and thus cash return for shareholders. Over the past 20 years, Nordstrom has consistently increased cash divi-
dend, including through the 2008 recession period.
Going forward, we expect free cash flow to continue to grow, based on our assumption of $700mn capex per annum, or 4% of topline.
We also assume that the company will maintain the dividend payout ratio at ~40%. Nordstrom authorized a $1.5bn stock repurchase plan
in early 2018. While we have not factored in the impact from potential share buybacks, we would not rule them out considering
Nordstrom’s strong cash position and attractive current valuation.
Valuation
We value JWN at $94/share (46% upside) with a
very favorable risk-reward profile as the base case
return represents almost 3x the downside of our
bear case scenario. We believe JWN merits a sum-
of-the-parts valuation given its underappreciated and
multifaceted business model, and derive our segment
multiples based on an analysis of peer comps. Our
target price of $94 assumes a 9.7x blended multiple on our $1.8bn FY20 EBITDA estimate, based on i)
5x department store multiple, ii) 12x off-price multiple, and iii)15x e-commerce multiple. Furthermore,
our above-Street EBITDA estimates are driven by higher sales growth at Rack and online, as well as a 40
basis points EBITDA margin improvement, to 10.7%. Our bull case results in a $107 price per share
(70% upside) and is based on a 10.4x blended multiple applied to a $2.0bn EBITDA, while our downside
case results in a $54 price per share (16% downside) and is based on a 7.3x blended multiple applied to a
$1.4bn FY20E EBITDA.
Key Risks and Mitigates
1) Growing threat from e-commerce
Although e-commerce continues to take share from retail,
Nordstrom is well-positioned to benefit from these tailwinds
given its digital investments and expectations that it will grow e-
commerce to 40% of sales by 2022. In addition, Nordstrom has
differentiated its e-commerce platform by offering a curated se-
lection of higher-end items, being less promotional than competi-
tors, and investing to develop best-in-class online capabilities.

2) Department store competitors are becoming increasingly promotional on price


Nordstrom has historically been successfully at running fewer promotions than its department store peers due to its differentiated high-
end offering. This strategy combined with the ability to push stale inventory to Nordstrom Rack stores helps reduce the need to run pro-
motions.

3) Nordstrom operates in a cyclical industry


Our bear case reflects a recessionary scenario, resulting in a $54 price target. While this price target represents a 16% downside to the
current stock price, we believe the risk/reward profile justifies our buy recommendation.
Conclusion
We believe that the risk-reward profile for JWN shares is positive, given market perception of Nordstrom as a traditional department
store when in reality its higher-growth e-commerce and Rack drive over 50% of the business. Continued outperformance in these favora-
ble pockets of retail will drive cash flow growth and valuation re-rating.
Page 15

Lions Gate Entertainment (NYSE: LGF.A) - Long


2018 CSIMA Stock Pitch Challenge — 1st Place (Nov. 2018)
Amit Bushan Bruce Kim Stephanie Moroney
ABushan20@gsb.columbia.edu HyKim20@gsb.columbia.edu SMoroney20@gsb.columbia.edu

Recommendation
We are recommending a long of Lions Gate Entertainment (LGF) Trading Statistics (as of 1/23/2019)
with a price target of $26, representing a +44% upside.
Business Description
Amit Bushan ’20 LGF is a diversified entertainment company with 3 segments: 1) Mo-
Amit is a 1st year student at tion Pictures; 2) TV Production; and 3) Starz, a premium cable net-
CBS. Prior to CBS, Amit was at work the Company acquired in December 2016. As of FY2018, Starz
Energy Capital Partners, an
energy-focused private equity accounted for 37% of total revenue and 66% of EBITDA. Starz has 2
firm. subscription programs: 1) linear pay TV service bundled in cable TV
packages; 2) streaming-only OTT service (launched in April 2016).
Variant Views
1) The Street misunderstands the streaming service market
as a winner-takes-all market
 A recent survey by Video Advertising Bureau showed that 1/3 of US households subscribe to 3+ stream-
ing services. Even with 5~6 streaming services, the total monthly cost (~$50-70) is below that of a tradi-
tional cable TV package (~$100-130). Therefore, premium cable networks (e.g. HBO, Starz) can grow as
complements to larger streaming services. Note that both Amazon Prime and Hulu, operating as digital
distributors, offer premium networks as add-ons.

Bruce Kim ’20


Bruce is a 1st year student at
CBS. Prior to CBS, Bruce was a
global macro PM at BlackRock.
In summer of 2019, Bruce will
be interning at Alyeska Invest-
ment Group.

 Our conversation with an industry executive of a premium network confirmed the multi-player dynamic
of the streaming market: "Consumers view Netflix and Hulu as complements. Most viewers don't consider the
cost of Amazon Prime coming from the same wallet. So that leaves room for around 2-3 additional services." This
is also in-line with management's view of Starz's competitive positioning (“…we want to position Starz as
being an addition to Netflix, not a replacement of [it]” - Jeff Hirsch, COO of Lions Gate, 10/4/18).
 Starz is well positioned as a complement to Netflix/Hulu due to its 1) low price ($8.99/mo vs. $14.99/mo
for HBO and $10.99/mo for Showtime); and 2) differentiated target audience (focus on female and Afri-
can-American demographics – segments missed by other networks).
2) The Street is overestimating the decline in Starz linear Pay TV subscribers
 In the last 2 years, Starz lost 4.5M linear subs, with half of the drop coming from telco. The Street contin-
ues to model a steep decline in linear subs going forward, extrapolating the recent trend. However, the
drop in telco subs was impacted by a one-off factor: after DIRECTV acquisition, AT&T promoted migra-
Stephanie Moroney ’20
tion from its U-verse (high penetration) to DIRECTV (low penetration), resulting in subs losses for Starz.
 With the migration complete, we are modeling a more moderate pace of linear subs decline vs. consen-
Stephanie is a 1st year student at sus. Recent results support the thesis: 2 quarters of
CBS. Prior to CBS, Stephanie
was an equity research analyst at linear Pay TV subs gains.
Anchor Capital Advisors, a value
-focused investment manage- 3) The Street is underestimating the growth of
ment firm. Starz OTT subscribers
 The Street is modeling a moderation in OTT subs
growth going forward (~5M by 2021). Note that the
Street has consistently underestimated Starz's OTT
subs growth trajectory.
 We are modeling that the company will maintain the
recent pace of OTT subs gains (1.5-2M/yr) for the
Page 16

Lions Gate Entertainment (LGF) - Long (Continued from previous page)


next 3 years, reaching 7M subs by 2021, driven by: 1) digital distribution/international expansion (2018: YouTube Live, Hulu, Amazon
UK/Germany; 2019: France, Italy, Spain, Canada); and 2) increased investment in original content. The company has also been inte-
grating 3 divisions: Starz has a first-look deal on all shows developed by the TV production segment and has access to the film seg-
ment's IP (e.g., Starz is currently developing a new show tied to the John Wick movie franchise).
4) Lionsgate remains an attractive acquisition target
 Industry executives noted the upcoming "content scarcity" around 2020/21. With Disney/Warner launching OTT services, large por-
tions of content libraries will be locked out of the market. Therefore, the value of LGF's film library (16,000 films) is set to appreciate.
Given the company's content library, film/TV production studio, and Starz, LGF remains an attractive acquisition target for media
companies trying to expand their operations as well as for new entrants to the industry (tech, telco).
 In 2017, EPIX (a smaller premium network) was acquired at 11x. Given that EPIX had no original content, no OTT capability, and a
small film library, Lionsgate should trade at a premium. According to Variety, Hasbro offered around $40/share (~15.5x EV/EBITDA)
before talks broke down last year: “The toymaker wanted to offer the company more than $40 a share, but Board Chairman and lead share-
holder Mark Rachesky thought Lionsgate was worth more and killed the pact, insiders say.” (Variety, Feb 27, 2018). We are modeling a 13x
target multiple (mid-point of 11-15x) for the M&A scenario.

Valuation
 Above-consensus subs
projection results in a
12% above-consensus
NTM adj. EBITDA.
Given the FCF stability
of the subscription-
based business, we are
applying a premium
over movie studios
(~10x). Note that 12x
multiple is 12% lower
than Starz’s recent
average (13.7x).
 Catalysts: 1) higher-
than-consensus OTT
subs growth in the
next few quarters; 2) increased visibility on the impact of the international expansion; 3) M&A.
Key Risks and Mitigants
1) Volatility of the Motion Pictures segment: LGF takes a risk-mitigated approach to its film slate. Management is scaling down the
film segment vs. Starz.
2) Cyclical risk: Low monthly price mitigates the risk of a spike in churn rate during a recession.
3) Talent cost inflation: Starz has been successful at developing and maintaining new talent. Note that its two flagship shows
(“Power” and “Outlander”) were both developed by relatively new showrunners.
Page 17

Polen Capital
(Continued from page 1)

University of Chicago economics. I effectively used ambitious goal of attending


Booth School of Business. this as a stepping stone to Columbia Business School –
transition into the money the institution where Graham
Jeff Mueller ’13 joined management industry. I taught and Warren Buffett
Polen Capital in 2013 and worked for Morningstar as an trained. I was fortunate to be
is currently Co-Portfolio equity analyst after graduation, accepted into CBS and,
Manager of the Global joined Polen Capital about a subsequently, the Value
Growth Portfolio. Prior to year later, and have been at Investing Program. It may be
joining Polen, Mr. Mueller Polen ever since. Despite going considered blasphemous to say
spent ten years in the US to the University of Chicago – this in Graham and Doddsville,
Marine Corps, during the birthplace of the efficient but at CBS, I came to realize
which he logged over 400 market hypothesis – I’ve that the best way to
Damon Ficklin hours flying combat always been a Warren Buffett compound wealth over time is
missions in F/A-18 and Benjamin Graham junkie. to invest in high quality
Hornets. He ended his I’m happy to have found an businesses, not in cigar butts.
tour as an instructor at opportunity at a firm that This led to a desire to work
MAWTS-1, the Marine adheres to many of Buffett’s for a firm that invests in high
Corps version of Top Gun. and Graham’s tenets. quality businesses in a
Mr. Mueller earned a B.A. concentrated manner with a
in Communications and Jeff Mueller (JM): In 2001, I long-term orientation and that
Business Administration was living in Texas and training also has a terrific culture.
from Trinity University to see if I could become a Coming from a Marine fighter
and an M.B.A. from professional tennis player. My squadron, which has a culture
Columbia Business School plans completely changed on of purpose, teamwork and
where he graduated from September 11th, 2001. After service, it was important for
the Value Investing the second plane hit the North me to find the same culture at
Program with Honors and tower, I decided to join the US my first post-Marine Corps
Distinction. Mr. Mueller Marine Corps where I spent 9 job. I found all of that at Polen
Jeff Mueller ’13 also teaches at Columbia ½ years on active duty flying in Capital, which I joined
Business School as an F/A-18s. While I was deployed immediately after graduation. I
Adjunct Professor. to Iraq flying combat missions, have now been at Polen for
someone sent my squadron- about 5 ½ years and have been
Graham & Doddsville mate an investing book that managing the Global Growth
(G&D): Can you start by introduced me to Ben Graham portfolio with my partner,
discussing your background and opened my eyes to a Damon for the last 1 ½ years.
and how you got into the world I had previously not
business? known. That book inspired me DF: Polen has a long history of
to read The Intelligent Investor, successfully managing
Damon Ficklin (DF): I have which I quickly devoured, and concentrated growth
both a bachelor’s and a any other Graham works I portfolios with a business-
master’s degree in accounting could get my hands on. It owner mindset. The large
with a focus on taxation. That sounds surreal, but I can still company growth team, which
led me to PwC after college, picture myself sitting in an Jeff and I are a part of, is one
where I worked in airbase in the middle of the fully-integrated global
international tax for about four desert reading Graham investment team executing a
years. My long-term aspiration between missions. His words proven investment discipline
was to be in money really connected with me: I across three different
management, but I thought quickly realized that investing portfolios. Our flagship Focus
that public accounting is the last Renaissance Growth portfolio, which
experience would be a solid occupation and that I wanted started in 1989, is invested in
building block. After my time to make a career out of it the best growth companies in
at PwC, I earned an MBA from when I left the Marines. the U.S. Our Global Growth
the University of Chicago portfolio, which launched at
Booth School of Business with My chance encounter with the beginning of 2015, invests
concentrations in finance and Graham pushed me to set the in our best ideas anywhere in
(Continued on page 18)
Page 18

Polen Capital
the world. International guardrails which have been in simply by adding leverage. This
Growth, which launched at the place since the inception of the is why we also demand low
beginning of 2017, invests in firm. We are looking for levels of debt in our
the best growth companies companies with (1) a return on companies.
outside the U.S. equity above 20%, (2) an
exceptionally strong balance Once we apply our five
G&D: Was there any strategic sheet, (3) stable to improving guardrails, our investible
reason why Polen chose to be margins, (4) abundant free cash universe of companies drops
based in Boca Raton, Florida? flow, and (5) real, organic to roughly 350 companies.
revenue growth. From there, we study these
DF: David Polen, the firm’s companies extensively, aiming
namesake and founder, began “The [pre-mortem] is to remove businesses that are
as a broker in New York overly cyclical or driven by an
before moving to Tampa, to reverse-engineer unsustainable fad. We have
Florida to bootstrap the traditionally avoided materials,
business in an area with a explanations for how utilities (not enough growth),
more affordable cost of living. telecom (too capital-intensive
By 2002, when the investment a company can and cyclical), energy, banks
track record was well- hypothetically (overly leveraged with opaque
established and he wanted to balance sheets), and real
attract talent to build the become the worst estate. Our overarching goal is
business, he decided to move to construct a portfolio of
the firm to Boca Raton, investment Polen has roughly 25 high-quality,
Florida, where we are based competitively advantaged
today. Boca Raton is far from ever made. It's an businesses that generate
New York, but we believe consistent mid-teens earnings
being disconnected is a good interesting exercise growth, with the belief that
thing. We have a unique because it can show stock appreciation will follow
investment philosophy and the earnings growth over the
process, which is built upon how strong – or weak long term.
independent fundamental
research. We are not – our investment After filtering out cyclical
concerned with what anyone businesses and businesses with
else thinks of the companies thesis is; the harder it more temporal growth
we own. In that way, we think prospects, we are left with
it is actually an advantage to be is to come up with about 100-150 companies,
on an island of sorts. plausible pre-mortem which we call our coverage
universe. These are the
G&D: Can you elaborate on reasons, the more businesses that we spend most
your investment process and of our time on. One of the
how it’s unique? likely a company is advantages of holding positions
for an average of five years is
JM: I think what is probably special.” that there’s no rush to get the
most unique is that we have next idea in the portfolio; the
consistently executed a While each of these guardrails goal is to truly understand the
process that hasn’t changed in sets a high bar individually, competitive advantages that
any significant way for more looking for companies that protect the business and the
than 30 years. We owe a large meet all five becomes an sustainability of those
part of our success to our exceptionally high hurdle. For competitive advantages going
discipline in sticking with our example, while an ROE of 20% forward. I believe Charlie
process. We begin with a very or greater is roughly double Munger said that the first rule
large universe of about 3,000 the corporate average and of fishing is to fish where the
companies globally, but we signals a strong competitive fish are. We believe we are
quickly whittle that down by advantage, it is possible for a fishing in a stocked pond.
applying five investment business to increase its ROE
(Continued on page 19)
Page 19

Polen Capital
One of the last things we do is deliver significant excess
a pre-mortem on the DF: We would put returns while also capturing
companies. This is taken from concentration at the top of less of the downside than 90%
the discipline of social that list. We have about 25 of our peers.
psychology. The exercise is to positions in the Global Growth
reverse-engineer explanations portfolio, which we think is a The second advantage that we
for how a company can big advantage from two would highlight is our long-
hypothetically become the perspectives. From a term holding period. We’re
worst investment Polen has performance perspective, by not trying to generate returns
ever made. It’s an interesting concentrating in the best by buying and selling stocks; in
exercise because it can show growth businesses, we can fact, half of the Global Growth
how strong – or weak – our construct a portfolio that holdings have been in the
investment thesis is; the harder grows underlying earnings portfolio since inception (over
it is to come up with plausible faster than the market. This is four years ago). And to use
pre-mortem reasons, the more what we believe drives excess our Focus Growth portfolio as
likely a company is special. returns over time. From a risk another reference point, we’ve
From there, Damon and I perspective – which is arguably only owned about 120
apply critical thinking and even more important – companies in that portfolio
judgment and choose the best portfolio concentration in only over the past 30 years.
~25 businesses. the highest quality businesses
reduces risk. We also believe we have an
G&D: Can you touch on how advantage in the way we put it
you put the portfolio together? all together to manage risk. As
“What looks expensive Jeff described earlier, we only
DF: We like to say that we consider high-quality business,
are investing across the growth in terms of the next- which removes a lot of risk at
spectrum. On the left side of the front-end of the process.
twelve-month P/E
the spectrum you have steady We are also quick to adjust to
businesses that grow at a becomes more any new risks that emerge in a
higher-than-average, but more business. We don’t want to
moderate and dependable rate. reasonable if the take any undue risks with a
On the right side of the concentrated portfolio, and
spectrum you find quality business is growing our track record shows that
companies growing at much we don’t need to. We have
higher rates, perhaps 20-25% earnings at a 20-25% produced strong returns not
per year and above. Of course, because we have taken big
rate and the stock isn’t
these businesses often have risks and have been right, but
higher multiples as well. We following along.” because we have avoided
are happy to own higher taking unnecessary risks.
growth companies such as
Adobe or Tencent that have a We’ve had among the best G&D: To what degree does
higher valuation, as long as the downside capture across the engaging with management
business fundamentals support industry in our flagship fund factor into your process?
it. What looks expensive in over the past 30 years, and our
terms of the next-twelve- Global Growth fund is DF: We engage with
month P/E becomes more following in the same management, but it's not the
reasonable if the business is footsteps. In the four years most important thing that we
growing earnings at a 20-25% since its inception, the Global do. We meet with
rate and the stock isn’t Growth portfolio has management maybe once a
following along. compounded at about 11% year. We really try to put the
compared to just over 4% for picture together with publicly
G&D: Aside from your unique the MSCI ACWI (all country available information before
investment process, what else world index) and ranks in the we talk to management.
separates Polen from other top decile for downside Management conversations
investment firms? capture. We have been able to tend to confirm what we have
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Polen Capital
already learned. If the situation two enterprises to about 10% miss one of your guardrails?
is so complicated that we can’t of the portfolio – we think it is
understand it without having a highly unlikely that the Chinese JM: This goes back to our
conversation with government would do anything approach on strategically
management, that would be a to usurp these assets. These thinking through what is
red flag. companies are highly visible happening today and what
The judges’ panel for the businesses that have significant could happen over the next
4th Annual CSIMA Stock JM: We don’t meet with foreign institutional ownership. five-plus years. Alibaba is not
Pitch Competition management to ask about Any meaningful effort to assert only more dominant today, but
quarterly inflections or direct control over these it's also more profitable and
catalysts. We understand the businesses would likely result has higher returns on capital.
business model, so when we in foreign capital flooding out JD's business is still heavily
meet we talk through their of China, which would be weighted towards their low
strategy over the next three to against China’s broader margin, capital-intensive 1P
five years or beyond. interest in becoming a global business which largely consists
hegemon. of selling consumer
G&D: Polen is currently electronics. Alibaba is
roughly half US and half “We appreciate completely dominant, and
international. Do you set a they're reinvesting heavily to
geographic target when
companies with high ensure they maintain their
building the portfolio? returns on invested strategic position.

JM: We do not target a certain capital and that We appreciate companies with
geographic mix. We tend to high returns on invested capital
think more in terms of where operate in both and that operate in both
the underlying revenue is being underpenetrated and
earned as opposed to where underpenetrated and expanding addressable
the company is domiciled. You markets. Both of these
can have a US business that
expanding qualifications apply to Alibaba,
does 80% of its business addressable particularly as China’s middle
outside the US, and vice versa. class grows from 300 to 500
We are mindful of what the markets.” million within the next few
mix is, but we are really just years. The company has a long
looking for the best businesses We also feel confident that runway to deploy free cash
while staying balanced over both businesses are well- flow at higher returns. Alibaba
time. aligned with China’s strategic has also reinvested heavily into
direction, particularly Alibaba. payments, as Alipay has
G&D: Let’s talk about specific China is trying to move become China’s leading
investments. You own Tencent towards a more consumer- payment platform. Their
and Alibaba. How do you think driven economy, and Alibaba is dominance is so impressive
about investing in China and essentially the backbone of that we think it will continue
state-controlled enterprises? commerce across China. to do very well against JD.
These businesses are Chinese
DF: We’re very thoughtful champions, helping propel the JD has had one main advantage
about how we invest in China. economy in a way that the over Alibaba: a built-up system
Most businesses in China are government really supports. of in-house logistics and last-
not investible for us today. We are mindful of having the mile delivery. However,
Even Tencent and Alibaba have wind at your back when Alibaba has arguably caught up
Variable Interest Entity investing in China, as opposed by leveraging their massive
structures, which is not direct to running into the wind, amounts of data and scale. Its
equity ownership. While that which can be fraught with logistics network, Cainiao, now
set-up is a risk factor and challenges. handles over 60% of Chinese
something we keep in mind – a packages, or 25 billion
reason we have limited our G&D: JD is one of Alibaba’s packages a year. With access
aggregate exposure to those direct competitors. Did JD to the over 600 million users
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Polen Capital
on Alibaba’s retail platform and market. we’ve owned since 2005) to
their 50 billion annual see what the transition to
transactions, Cainiao is using G&D: Alibaba sounds like a cloud would be like and how
advanced machine learning to compelling investment. Are significant the headwind would
“guess” where a purchase is there other names that you’re be to revenue. As we were
most likely to happen and plan excited about that hit all five doing the research, we started
the logistics accordingly. A guardrails? thinking, “Alright, the cloud's
more efficient logistics obviously a good thing for a lot
network will likely further DF: Adobe is a great example of companies even though
widen the gap between Alibaba of a company that we’re really they’re going through some
and its competitors. excited about – there’s a short-term headwinds. Who
reason why it’s our top holding else is really benefiting from
Alibaba’s current take rate is in the portfolio. We think it this cloud transition?” Adobe
only about 3.5%, which pales in has a huge competitive was one of those companies.
comparison to Amazon’s 13%. advantage and a very strong
We think that rate should go opportunity to continue to In December 2011, Adobe
up over time. We are watching reinvest back into the business decided to stop selling
these Chinese companies at high incremental returns. packaged software for its
execute similar strategies that creative content and
our team studied in the past Adobe basically has two transitioned to a subscription
with eBay and Amazon. For businesses. One is Digital model. That strategic shift was
example, third-party sales Media which is the creative attractive to us because the
became a big part of Amazon’s side and about 70% of the company went from a boom-
business model between 2000 business. That’s content or-bust revenue cycle, where
and 2002. The introduction of creation, software like every two years customers
3P increased profitability and Photoshop that allows users to may or may not upgrade to the
was also strategically effective: edit photos and create videos. newest version of the
3P is a high-margin business software, to a more
given that Amazon merely Digital Experience is the other predictable and sustainable
takes a cut of transactions, it 30%. Firms are transitioning revenue cycle where Adobe
allows for a greater selection their marketing away from could easily raise prices.
on the platform without added traditional channels like Adobe effectively holds a
inventory risk, and it newspapers, television, and monopoly in this space; there’s
strengthens the Amazon magazines and toward digital really nowhere else to go if
network effect by attracting channels. With Digital you’re a professional and you
more buyers (and by Experience, Adobe will want to create digital content.
extension, more sellers). conduct entire digital
marketing campaigns for We spent roughly 15 months
However, Amazon struggled companies and run very fine- researching Adobe, trying to
with scale problems during this tuned analytics. Adobe can tell answer questions like, “What
period of rapid retail business you how long someone is the growth rate of Digital
growth, forcing the company hovered their cursor over a Experience? What is the value
to build many of its own link, what they clicked on, how proposition? Are there
systems to deal with long they watched a video, synergies between Digital
application, computing, and etc., while also creating a Media and Digital Experience
storage needs. That led to the unified customer profile in the that create an even greater
birth of Amazon Web Services, background. This is basically a competitive advantage than
currently Amazon’s most code that informs companies, what you might see on the
profitable division. We saw with a fair degree of accuracy, surface?” It turns out there are
Alibaba benefit from a similar who you are and what you’re deeper synergies. Since Adobe
rise in 3P growth and we’re most likely to buy online. is a monopoly on the creative
also seeing the same pattern side, any company that signs up
play out with Alibaba Cloud, JM: We found Adobe in 2013 with Adobe to run a digital
which now controls almost half when we were doing a big marketing campaign will also
of China’s cloud-computing exercise on Oracle (which end up using Adobe’s creative
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Polen Capital
content for their digital media. call 100 different people if or become a more significant part
All the code is the same, so when things start going wrong. of the business over time.
nothing gets lost in the The full-suite offering ensures Starbucks is growing store
transition between the that everything is integrated count in China in the high-
creators and the marketing and you have just one point of teens. That has had some
people. It all works seamlessly. contact. impact on same-store sales
That functionality informs the which are now relatively
decision of a lot of large What makes this even more flattish after being as high as
companies as they choose potent for Adobe is that their 8%+ a few years ago.
Adobe over a competitor. full-suite offering also includes Moderating comps, plus an
best-of-breed point solutions. intensifying competitive
We later realized that there’s This makes it very difficult for environment with the entry of
this secular tailwind where other software vendors to local players like Luckin
digital marketing is becoming compete. We think Adobe is Coffee, are undoubtedly short-
increasingly important for well-positioned to continue to term headwinds.
companies not only to survive compound earnings in excess
but to thrive. That has created of 20%. We feel margins can Nevertheless, Starbucks has a
even more demand for digital still expand over time, with the very strong established
content creation. Not only are high quality of the business position in China, which is a bit
the two businesses helping sell acting as the investment’s of a land-grab market. They
each other, but they’re both margin of safety. have thousands of stores. They
growing due to the same have a real brand experience
secular tailwinds. G&D: We noticed you also which is not really being
own Starbucks. Building on our challenged. I think they have
We think management has earlier discussion of China the right strategy there, which
done a good job of broadening transitioning to a consumer- is not to optimize for same-
their Digital Experience driven economy, do you view store sales but rather to open
business and expanding their Starbucks as a stock where more stores. They’re playing
product offerings. Previously, if most, if not all, of the growth the long-term game instead of
a company used Adobe’s digital in the future is going to come taking easy short-term wins.
marketing, they’d have to use a from China?
third-party company to enable Additionally, the store-level
their clients to check out. That DF: We expect continued economics in China are as
gap no longer exists following growth from both the US and good as they are anywhere in
Adobe’s acquisition of from China. The US is the world. Usually, US-based
Magento, an open source e- currently 70% of Starbucks’ companies that try to expand
commerce platform. Adobe’s business. Though the region is abroad aggressively chase after
ensuing purchase of Marketo, a certainly more mature than growth markets at the expense
B2B digital marketing services China, it is still a meaningful of profitability. They try to
provider, further bolsters its contributor to overall growth. build a beachhead and grow
product lineup. Starbucks is growing store into new areas with the hopes
count at about 4% annually in of making money in the future.
Tapping into Polen’s the US, a rate which has been But for Starbucks in China, the
experience, we found that for pretty consistent over the past overall economics and cash-
enterprise software, the full- several years. Same-store sales returns of stores are actually
suite offering usually wins out have moderated from high quite good. So, not only is it
over best-of-breed point single-digits a few years ago to the right strategy to accelerate
solutions. It’s logical – if you're what we think will be a store growth, it’s a good
the deciding person for sustainable 3-5%. Aggregate return strategy as well.
enterprise software growth in the US, though more
purchasing, you don't want 100 modest than it historically has G&D: Is there any worry the
different point solutions, been, is still quite healthy. trade war might shift Chinese
because not only is there a preferences away from
chance that they won’t China is certainly a bigger American companies to
integrate well, but you have to growth opportunity and will domestic brands like Luckin?
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Polen Capital
position a couple of times after owning it in our Focus
DF: I think there’s enough throughout last year because portfolio for a long time. We
opportunity in this market for the valuation had become a believe Invisalign is similar to
more than one player to have little more demanding. It Allergan and its Botox
some growth, but you need to turned out to be fortuitous product. Botox has been off-
grow in the right way. It's timing, since they had a bit of a patent for decades, yet it’s still
funny because you have hiccup last quarter which a very powerful brand and the
companies like Luckin that are brought the stock down go-to for people that want to
taking this technology business quickly. get rid of wrinkles and look
model approach like, “We'll younger. Most people can't
just grow. We’re not going to Two things happened last name Botox’s competitor (it’s
worry about profit. We’ll make quarter that repriced the a brand called Dysport). We’ve
money tomorrow.” That might stock. First, promotions for found that the Invisalign brand,
make sense in certain Invisalign aligners didn’t turn even though it’s still patented,
technology businesses where out as well as expected, has all the hallmarks of the
there’s a network effect, but putting downward pressure on brand equity that Botox has.
we don’t see that here. Luckin average selling prices. Second,
is just building stores. The new competitors entered the We also have a view that
consumer could wake up in market. Combine those vanity is increasing across
two years and say, “If you’re developments with a rich humanity. First, you have the
not giving me a discounted cup valuation, plus the negative creation of the internet, and
of coffee then I’ll go to market environment last the advent of smartphones and
Starbucks.” You don’t have quarter, and investors got social media shortly after.
that lock-in effect like you do scared. Now, sadly for our children,
in other businesses where you humans are taking more
see that type of approach. It’s a pictures of themselves than
competitive environment, but I “We have a view that ever before, which means that
think brand definitely matters. people are more into their
vanity is increasing
faces and, by extension, their
Moreover, there’s probably a across humanity.” smiles. We think that fits right
multi-tiered marketing into what Align is bringing to
opportunity in China. There market with Invisalign.
are some consumers that are We looked at all of those
going to be price-sensitive and factors and determined that We first saw this market shift
won’t go to Starbucks to buy a they were short-term with adults. Many adults that
$4 latte. But there are other challenges and that the got Invisalign wouldn't feel
consumers that do want the business is still in a very good comfortable going into a
brand, that will pay a premium position for the long-term. The professional workspace with
to carry around the mermaid valuation is reasonable again, braces on, making braces a non
on the cup. I don’t think so we brought the position -starter. We’re now seeing
anyone is challenging Starbucks back up to a 2.5% weight in the that trickling down to teens
on all dimensions, and it’s a big portfolio. While it wasn’t an and children.
enough market for more than outstanding year in terms of
one player. Starbucks is going share price for Align, the stock Clear aligners are more
to do just fine as time passes. was still a strong contributor aesthetically-pleasing than
in our portfolio because of wires and brackets. They’re
G&D: Can you give your take solid position management. also healthier. You can’t floss
on Align Technology? They had while you wear wires and
a rough 2018 with the stock JM: We still love the business, brackets, which can lead to
dropping about 50%. Do you and it is worth noting the gum irritation, at a minimum,
still feel that clear aligners will importance of historic and potentially even gum
eventually replace braces? perspective and how it disease. It’s an easier and more
benefitted our understanding time-efficient process, as
DF: We still own Align, of Align. Damon knows technology with clear aligners
although we trimmed the Allergan exceptionally well has advanced to the point
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Polen Capital
where clear aligners are out there that might need a
generally quicker than wires G&D: Can you talk about the few aligners. They might want
and brackets. purchase decision and how it’s to straighten one tooth out
made? Does the orthodontist but they’re not going to pay
We think the sub-10% market make the decision about what much for it and they’re willing
share that Align holds today in brand customers use and is to take on a lower-end direct-
teeth correction procedures is there any real threat from to-consumer product. That’s a
only going to grow from here. direct-to-consumer brands in customer that Align is probably
Honestly, if wires and brackets the space? not going to win. There’s
are still around in 20 years, room for different players in
then clear aligners have really DF: The dentist or different segments of the
done something wrong. orthodontist can make a market, so we don’t think it’s a
recommendation and steer long-term problem for Align.
G&D: That’s a very strong you towards different types of
case for the industry. Why do products and alternatives. But G&D: Thanks for that insight.
you think Align is better most of the alternatives are Do you have any advice for
positioned than its competitors only for very moderate cases. MBA students looking to get
in the space? Only Align has the capability to into investment management?
treat extreme cases such as
DF: While putting this little extractions that require teeth JM: I’ll give three pieces of
piece of plastic in your mouth removal and palate advice: two on perspective,
to shift teeth seems simple, restructuring. and one on how to improve
optimizing the biomechanics perspective. First, investing can
and algorithms behind the As for threats from direct-to- be a long career. Even if it
technology and then mass- consumer businesses, Align takes you five years to break
producing these aligners at explored that model but into the right place with the
scale is incredibly complex. No ultimately decided to go in a right people who compound
set of teeth is the same. Align different direction. It would be capital in the right way, five
is essentially mass-producing very easy for them to target years represents only 10-12%
snowflakes on demand and lower-end treatments. But of your total career, which
then shipping them to a widely Align has always kept the isn’t much.
distributed set of dentists and dentist and the orthodontist at
orthodontists all over the the center of the experience. Second, the investing industry
world. They’re doing other things to should be approached with the
pull more people into the goal of lifelong learning and an
On top of all that, Align also market but they're always understanding that you’re
has the patents underlying the trying to direct them to the compounding your knowledge
technology in addition to its dentist or orthodontist, not over time. It’s important to
strong brand equity. If a dentist work around them. That’s keep in mind that the industry
or an orthodontist brands their channel – Align believes lives on an exponential curve.
their practice – and here’s the that you want a quality This means you will experience
parallel between Align and healthcare professional long plateaus without
Botox – with the Invisalign managing this outcome. noticeable improvement, with
product, there’s going to be They’re creating all the tools the key word being
little incentive to move away to make it incredibly simple to “noticeable.” There will be
from that. Once you build that get great outcomes, but they inflection points; you just
brand into your practice and still want to prioritize won’t know when. Grow to
become comfortable with it, protecting the relationship embrace, or even love, the
you’re not going to switch with the professional. plateaus.
unless there's something much
better or much cheaper – and You could think about this as Finally, consciously develop
even then you need to think market segmentation, just as your values and moral
twice because you don’t want we were discussing with compass. One way to do this
to diminish the patient Starbucks and Luckin Coffee. comes from Charlie Munger,
experience. There’s a certain population who said, “Read history, read
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Polen Capital
history, read history.” Don’t contributing to others.
do it to memorize facts to
impress people, but do it with G&D: Thank you so much for
the understanding that your time.
decisions made in the past
were made by people with the
same cognitive makeup that
you and I have. When reading
about frauds, catastrophic
decisions, and decisions based
on weak values, try to
understand what led to those
decisions, and think about how
to improve your own
judgment to prevent yourself
from making similar mistakes.
Reaching the point where your
values and your moral compass
are impenetrable will make
your life better because you
will have earned the trust of
people you work with, and
there is a good chance your
example will influence others
along the way.

DF: Don’t compromise your


vision for yourself. As you
complete your studies and
begin your career in
investment management, make
sure you set sail in a direction
that you believe in. Prioritize
principles over money and join
people that you respect and
can learn from. I understand
the desire to repay the student
loans and to monetize all the
learning that you’ve already
paid for, but there’s much
more to learn. You’ll be better
off if in the long run if you
decide to double down and
invest in yourself again. If you
guide yourself with the right
principles and align yourself
with the right people, then
you’ll learn how to create real
value for the people that
ultimately entrust their money
to your care. If you do that
well, the money will come, and
you’ll be able to feel good
about not just what you’ve
accomplished , but what you’re
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DG Capital Management
(Continued from page 1)

cum laude. Mr. Gertzulin is met with the CEO of General spent the next five years as an
the Co-Chairman of the Motors, which was pretty analyst and as a co-portfolio
Investment Committee of exciting for someone who was manager. During that time, I
the Baruch College Fund still in college. really dug deep into value
with responsibility for investing: how to value
overseeing the Everyone else went back to companies and how to find
endowment. He is an avid school when the summer undervalued companies. That
hiker as well as a Trail ended, but since I was going to was a very productive period
Maintainer of the Long school in the city, they asked for me.
Path. me, “Would you want to work
here part-time during the During that period, I also
Graham and Doddsville school year?” I said yes. That received my MBA at NYU and
Dov Gertzulin (G&D): Dov, thank you for was an incredible opportunity. studied distressed investments
chatting with us today. Can I then started working in and bankruptcy law. I realized
you introduce yourself and research at Neuberger. I was over time that, while buying
discuss how you became 20 years old, and they would something very cheaply was
interested in investing? send me to these IPO lunches good, what’s even better is
for companies like Blackberry marrying that with a catalyst or
Dov Gertzulin (DG): I grew and Palm. Those companies a specific event to unlock
up in Brooklyn and, from a were going public then, and a value, or looking in the parts of
young age, was interested in lot of these companies don't the market where there is less
investing. I heard about exist anymore. It was an competition. Doing this, you
Warren Buffett and got my absolutely crazy period when could find more compelling
hands on The Intelligent Investor. all ideas about value were opportunities than in just
After that, I started learning as completely thrown out the trying to find cheap stocks.
much as I could about Ben window and companies
Graham. I was a bit of a value routinely traded at 50x, 100x G&D: What convinced you of
investing nerd – I went to earnings, sometimes even that?
Berkshire Hathaway’s annual infinite amounts of earnings.
investor day many times and DG: One major influence was
even read Security Analysis. In 2000, I joined a hedge fund Columbia Business School
named JDS Capital. This was at professor Joel Greenblatt. At
G&D: You actually read the peak of the market. The that time, you could watch his
Security Analysis? world seemed completely classes on the internet, and I
irrational, and then we had a also read his book You Can Be
DG: I did. significant correction. A Stock Market Genius. Another
Subsequently, you had the influence was Seth Klarman at
G&D: Wow, that is somewhat ability to buy quality companies Baupost.
unusual to have read it cover- cheaply; I remember REITs
to-cover. trading at double-digit yields That led to the basis for DG
because no one wanted them Capital. I wanted to create a
DG: I actually have a first since they were not involved firm where we could be
edition Security Analysis, third with the internet or some sort passionate about uncovering
printing. Anyhow, I went to of exciting technology. In a deep value, and at the same
Baruch College to study sense, investing was very time able to invest across the
finance and investing. When I simple because you had quality capital structure – everything
was there, I got a summer companies trading at single- from first lien debt to post-
internship at Neuberger digit or low double-digit reorganization equity.
Berman. I was lucky to get the multiples of earnings and free Additionally, a focus of ours
job, but they put me in the IT cash flow. would be clear catalysts to
department. I didn't know the unlock that value, whether in
first thing about IT. I would I realized I wanted to go back the form of debt payment, a
sneak out and go to all the to a value-based investment high rate of interest, a special
investment and research process. I returned to dividend, a listing of shares, or
meetings that I could. We even Neuberger in 2002, where I a company putting itself up for
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DG Capital Management
sale. so much smaller than the DG: We started the fund in
number of funds that can buy mid-2007, which looking back
Distressed investments stock in IBM or Microsoft. seems like the worst possible
naturally display this When a company comes out time to start. Very few funds
framework, with situations in of bankruptcy, its shares are that started at that time exist
which a company goes through not listed on an exchange. You today. We didn’t get fully
a distressed event and the need to call a trading desk and invested until just about when
banks or the lenders then take bid on those shares, which is a the financial crisis was getting
over. In many cases, the back and forth verbal going. It was also a good lesson
lenders are not set up or are negotiation. The number of for us because late in 2008,
not able or willing to own the investors who can do that is when the world was in a very
equity or junior parts of the relatively small. Furthermore, difficult place, you had the
capital structure. As a result, in this space there are actors opportunity to buy debt in
you can buy into the company selling for institutional reasons companies that, in some cases,
at a significant discount to and not necessarily had more cash than debt, and
peers. fundamental reasons. were either profitable or not
losing any significant amount of
If you take a step back, I think money.
the reason why investing today “[1999-2000] was an
is so difficult is because we I remember investing in the
have so much more capital absolutely crazy period debt of JDS Uniphase when
available. You may have seen they had an approximately
when all ideas about
the recent National Bureau of $500 million debt issue that
Economic Research’s study value were completely was trading at 50 cents on the
that shows there were 4,943 dollar, as well as about $800
listed US companies in 1976, a thrown out the window million in cash. While that
total which grew to about scenario was certainly unusual,
8,000 at the peak of the and companies it showed that there are ways
market in 1996. By 2016, that to make money even in difficult
number had dropped to only routinely traded at 50x, periods. That was another
3,671 listed companies. Today, really important lesson for us:
100x earnings,
you have less than half the always keep a portion of the
number of publicly traded sometimes even infinite portfolio in the senior part of
companies than you had 20 the capital structure. From
years ago, and fewer amounts of earnings.” there it’s been a good journey.
companies than 40 years ago.
Yet our economy is so much G&D: Why do you think more
larger, the pool of capital is so We also invest in more classic capital hasn’t found its way
much bigger, and the number areas where people add value, into this space?
of people working in investing such as transactions in which
and graduating from business big companies spin off a small DG: I’ll give you an example
schools is so much greater. I business unit, or turnaround that should help answer your
think this makes it so difficult situations in which companies question. Take AMF, the
to outperform and add value. looking for financing may have largest bowling alley chain in
to issue convertible debt or the US. They were over-
The question is, where can you other debt instruments that levered and went bankrupt. In
add value as an investment have equity upside. We prefer the bankruptcy, the lenders
firm? I think you have to start to focus on middle-market merged the company with
by looking in a place where the companies rather than large, Bowlmor, which had two
vast majority of people aren’t multi-billion-dollar ones. locations in New York and was
going to be searching for an expanding across the US. It is a
investment, or where there G&D: Can you talk about the very profitable business. AMF
are structural advantages. The timing of when you opened was a mismanaged company,
number of funds that can buy DG? but at Bowlmor, management
first lien distressed debt is just came in and transformed the
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DG Capital Management
business from the league significantly grew earnings. G&D: That seems like an idea
bowling business, which has no They bought Brunswick’s which should have attracted a
growth, to the party event, bowling business. Bowlmor’s lot of attention.
corporate event type of shares, which weren’t listed
business. Have you been to a but did trade, went from $5 to DG: The fact is most investors
Bowlmor? $77 by 2017 after being lack a flexible mandate and
purchased by Atairos, a private need to buy something that
G&D: Not recently. equity firm backed by has a ticker. If you are able to
Comcast. They grew EBITDA buy significant companies on a
DG: They have bars and good from about $50 million to fractional basis, you can buy
food – it’s a high-quality approximately $160 million assets at very deep discounts.
experience. When the through acquisitions, cost- In many cases, these
company exited out of cutting, rebranding, and companies are set up to win
bankruptcy in 2013, I called the rebuilding the business. because you have a
CFO. We had a nice management team whose
conversation, and I reviewed incentives are aligned with the
the projections that were “If you are able to buy interests of the investors who
available in the bankruptcy put them in place. The
documents. I asked him, “Has significant companies valuation may also be
anyone else called you?” He extremely compelling because
on a fractional basis, you have a good business that
said no.
you can buy assets at just holds too much leverage,
I thought that was really with leverage then significantly
strange. The stock was trading very deep discounts. In reduced in the restructuring
at $5 and there was a plan to process. It really can be an
significantly grow earnings, but many cases, these attractive opportunity. Will
at $5 a share, the company more people try to exploit
was valued at less than 5x companies are set up that over time? Probably. But
EBITDA. There were we see opportunity for the
comparable businesses, such as to win because you enterprising investor who is
Dave and Buster’s, Chuck E. have a management willing to work really hard to
Cheese, movie theater chains, uncover these ideas.
other forms of entertainment, team whose incentives
that were trading high single- G&D: Can you walk us
digit, low double-digit multiples are aligned with the through your process and how
of EBITDA. you work to uncover these
interests of the ideas?
There was also a second lien
piece of debt that was yielding
investors who put them DG: Our research team
approximately 15%, for a in place.” sources ideas broadly. It starts
leverage of 4x EBITDA. with a focus on off-the-run
Additionally, you had the exit middle-market companies, with
first lien debt on which you Why was that opportunity an enterprise value generally
could make around 13%. We available? Why was it trading at below $1 billion. We follow
were also part of the financing such a massive discount? Even companies that are going
that allowed the company to though bowling is not a sexy through restructuring or into
exit bankruptcy. The shares business, the company still had bankruptcy, as well as post-
were not listed, but through strong cash flows. What’s the reorganization companies and
investment banks you could incremental cost of bowling? companies whose debt is
source the first lien, the It’s almost like software. trading at a big discount from
second lien or the common What’s the cost of electricity face value, or even companies
shares. for running the pins? It’s about that have had changes in
an 80-90% gross margin management, among other
Over time, Bowlmor’s business. special situations. We also
superior management team work closely with a
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DG Capital Management
proprietary network of to peers?” If we find the risks? Is there some way we
attorneys, restructuring valuation compelling, we then could hedge our position?”
advisors, middle-market ask, “What's the clear catalyst
lenders, sell-side trading desks, to unlock the value?” We don’t We own a position in Contura
and other industry experts to want to come back here a year Energy, the largest
source our ideas. from now and say, “We own metallurgical coal company in
all these cheap securities and the US. Metallurgical coal is
G&D: Do you have a sector they’re still cheap.” We want used to make steel. The
focus? to be in positions where there company was formed during
are clear catalysts that will the bankruptcy of Alpha
DG: We tend to invest in drive the return. Natural Resources. After
gaming and lodging, medical bankruptcy, Contura and post-
technology, business services, G&D: How else do these reorganization Alpha Natural
certain parts of the energy opportunities present Resources merged. There is
business, and natural themselves? always cyclical risk with a
resources. But our mandate is resource company like that,
broad. Our research process DG: Often, when companies but the shares trade at about
revolves around building our come out of bankruptcy, these 2.5x our estimated EBITDA,
own proprietary model. exit term loans offer rates of and maybe 3.5-4x free cash
What’s nice about many of interest far in excess of where flow. We think that this is
these companies is that you comparable companies would very, very attractive. As it
can’t just pull them up on have to offer their debt. This trades at a big discount to
Bloomberg, and there is often debt is usually refinanced peers, we may look to hedge
little to no research coverage. within a year or two. They our position against more
may issue it at 98 cents on the highly valued peers.
Private financials also offer us dollar, but if they refinance it
an opportunity. It's a risk, since within two years, they have to G&D: For your event-based
other people may have been pay 102 cents on the dollar. theses, do you actively engage
involved for a long time and You just made four points right management?
could be more knowledgeable there, and if you can make a
than us, but the reward is high high single-digit rate of return DG: Yes. We definitely make
because the market is less on the interest rate, something our viewpoint known to
efficient in those cases. We like LIBOR plus 700, you can management. We’re not loud
then ask ourselves, “Is earn a double-digit, equity-like activists, but we do engage
management aligned with us? return with a debt-oriented with management, especially in
What are their incentives?” investment. the distressed process. We’ll
That's a key question. What’s typically work with other
their history? What’s their In terms of equity, we look at creditors and engage with the
background? Do they have a the elements we already board and management to talk
track record of success? As I mentioned. For example, a about strategy, change, and
have done this for longer and typical situation we like is the how they can drive value.
longer, I have realized that one where a company
quality of management is a key generates high free cash flow G&D: Does part of your
factor. It’s too easy to lose and tenders for shares. analysis focus on who else may
money with poor management Another one would be a be investing along with you?
teams, and in many cases, situation where the company
when we’ve done extremely lists its shares on a major DG: Absolutely. There’s no
well, it’s with people who have exchange. To identify catalysts, question that you need to be
shown a track record of we ask ourselves questions like very aware of which firm owns
success. “Will the company be put up which part of the capital
for sale, or will a large special structure, or if a firm is a
Then we look at the situation. dividend be paid?” That’s really sponsor of the company, how
We ask, “Is it undervalued? Is our research process, after they typically conduct
it undervalued on an absolute which we ask ourselves “Do themselves in a distressed
basis? Is it undervalued relative we understand the industry situation.
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DG Capital Management
think it is very hard to predict of these companies are not
Furthermore, you also have to beyond 24 months from now. built to be on that level of
be aware of where you are in We need to have a clear thesis leverage. What we’ve seen in
the capital structure, asking like, “We’re trading at X these companies is that small
yourself questions like “Is today, which represents some problems cause distress. For
there a lot of first lien debt discount to what we think it's most of these companies, this
ahead of you that exposes you worth. Then, in a year from wouldn’t happen if they were
to significant risk?” If there is now, when the company sells heavily equity-financed.
first lien debt ahead of you, itself, pays a special dividend,
perhaps that debt will get lists the shares, or refinances G&D: We’re in what seems to
reinstated or refinanced, its debt, it could be worth Y.” be the late innings of a 10-year
making it much easier for the bull market. How do you
junior creditors to be the approach investing in
fulcrum and take over and/or “I have a big sign in distressed assets over such a
get a stake in the company. cycle?
Those are all things that need my office that says,
to be considered. DG: Our flexible mandate
“When the thesis allows us to invest in different
G&D: How do you think parts of the distressed cycle,
changes, sell.” It’s very
about how long to hold a which entails everything from
position and when to exit? difficult to follow that when companies are going into
distress and their debt is
DG: I have a big sign in my advice, but I suspect trading at a significant discount
office that says, “When the to par, to when they’re in
thesis changes, sell.” It’s very that if we only bankruptcy, and also includes
difficult to follow that advice, when they come out of
but I suspect that if we only followed that advice, bankruptcy and you can invest
followed that advice, over in post-reorganization equity
over time, we would
time, we would have avoided or in the exit debt. If you are
some mistakes. We continually have avoided some able to invest across that
ask ourselves, “Is the thesis entire distress cycle, you can
still intact?” If the thesis has mistakes.” always find opportunities.
changed but it’s too cheap to
sell, that’s a very difficult place Over the last few years, we
to be. I think a lot of money Many investors can’t do that have found some attractive
has been lost by the today. They don't have that opportunities in companies
investment community in time horizon. They’re focused that were bankrupt years ago
those types of situations. on their monthly and quarterly and which are now earning
P&L, and while we like to make record results, yet whose
We think our approach to money every month and every shares are still not listed on an
time horizon is a competitive quarter, we don’t think it is exchange. Sometimes, they are
advantage, especially in the helpful to focus on that. just now listing for the first
current environment. We time, paying special dividends,
don’t ask, “What will the G&D: What do you think is or selling themselves. For our
company be worth in a month driving this opportunity set? organization, it’s actually a very
or a quarter or six months?” exciting time to be harvesting a
The minimum amount of time DG: The big driver is private lot of those gains and, for
that we’re looking to hold is equity. Private equity was a example, selling these
one year. We’re asking, “It's zero business in 1976 and is companies to other publicly
trading here today, but what now a multi-trillion-dollar traded companies trading at
could it be worth in one year industry. Thousands of much higher multiples. It’s a
or two years, sometimes even companies that would have win-win. There are also private
three years?” We don’t go past been public are now owned by equity firms that can buy these
three years for a number of private institutions, and they businesses and pay a much
reasons. For one thing, we use significant leverage. Many higher price thanks to debt
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DG Capital Management
financing. name when you looked at it? doing. In addition to your own
due diligence, it is a clear signal
G&D: That’s an interesting DG: Yes, he was the largest that there is real value that can
approach to cycles. Do you shareholder and, along with be created here.
want to discuss any specific the company, did a joint tender
holdings? for the shares. Once we saw G&D: It seems like a lot of
that happening, it became value investors are orienting
DG: Sure. In 2018, our largest pretty clear to us that they themselves around the gaming
holding was the post-reorg thought there would be a industry and, potentially,
equity in Tropicana significant appreciation of the trapped value.
Entertainment. The stock was business and of the shares over
listed on the OTC market. We time. That was a clear signal to DG: Yes, definitely. We own
started buying in late 2016. us. Twin Rivers, which is another
Tropicana was trading at 4x casino that came out of
EBITDA and generating great bankruptcy. It just filed its
cash flow with almost no net “Everyone is looking registration statements and is
debt, at a time when nearly all merging with Dover Downs,
gaming and lodging companies for someone who can ticker DDE. You can see the
were trading at 8-12x EBITDA. historical financial performance
contribute to
Additionally, the regional at Twin Rivers, it has been
gaming industry was beginning performance. That is incredible. They operate one
to experience consolidation. of the leading casinos in the
the ultimate equalizer. U.S., up in Rhode Island, and
Why was it trading at such a also own one in Biloxi,
significant discount to intrinsic In the investment Mississippi, and just acquired a
value and peers? Well, it was few more in Denver.
closely held, and it was listed management business,
on the OTC market. That, in if you can add value, it Twin Rivers was trading at 3x
our view, created a free cash flow after coming out
tremendous opportunity to almost doesn't matter of bankruptcy and following
buy this asset, which had been the legalization of table games
distressed many years ago but where you came from in Rhode Island. We thought
was now run by highly qualified that, even though the shares
management. or where you've been. weren’t listed and you didn’t
know exactly when you would
That is the type of research If you can add value, be paid, you should still put
that we do. We married that there will be a place yourself in the position of
fundamental research with a acquiring as much as you could
deeply discounted valuation for you.” of a great business run by
and a trend towards quality people, and trading at
consolidation in the regional 3x free cash flow.
gaming space. That led us to This goes back to one of our
believe that this would be a fundamental tenets: the actions Over time, management has
prime asset to be sold. Finally, of management, the board, and done a great job of growing
you had multiple property the people who control a earnings and increasing the
upgrades which were starting company. If those individuals value of the business. Now,
to flow through in the are buying as many shares as they’re finally listing their
numbers. It was an extremely they can, that is something to shares on the New York Stock
attractive investment, and the really take note of. Historically, Exchange. I think that is a good
company ended up being we have found that for case study of what is possible
bought by El Dorado Resorts investors who are not on the through the whole distressed
last spring for about 10x board or inside the company, cycle.
EBITDA. it is very valuable to follow
what insiders with a history of
G&D: Was Carl Icahn in the success – like Carl Icahn - are G&D: You don’t have much
(Continued on page 32)
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DG Capital Management
exposure to retail, which Columbia Business School is a
produces a lot of distressed very prestigious school, but
names. Is that by design? the truth is, it almost doesn’t
matter where you come from.
DG: What you’ll notice in If you have great ideas, people
nearly every investment we in this business will value that
spoke about is the importance highly. That’s what this
of free cash flow, asset value, business is all about: having the
and earnings generation. We tools to find great
typically stay away from opportunities, and then doing
liquidations or declining the work and the research to
businesses, where we say uncover them.
“Well, it’s cheap, and maybe
one day it’ll be worth more Everyone is looking for
than what we paid for it, but someone who can contribute
still, it’s not growing in value.” to performance. That is the
We like buying operating ultimate equalizer. In the
businesses that generate free investment management
cash flow and where we can business, if you can add value,
look out in a couple of years it almost doesn’t matter where
and say, “This is an attractive you came from or where
business.” you’ve been. If you can add
value, there will be a place for
A declining retail business you.
where we might say “Well, it
could be liquidated, it’s worth I would add the importance of
more dead than alive,” is not making time for things that you
attractive or exciting for us. are passionate about. For me,
That’s outside of the area we enjoying the outdoors and
typically focus on. In our view, being physical helps clear the
companies that generate free mind.
cash flow and have long-term
value are the companies that G&D: Thank you very much
over time make for the most for your time.
rewarding investments.

G&D: Perhaps we could close


with advice for MBAs?

DG: I still believe in the


investment management
business. People want to
compensate people who have
great ideas. Read, do research,
and you’ll be shocked at what
you uncover. Always have two
or three ideas at your
fingertips when you meet with
a prospective investment
manager for a position. What’s
your best idea? What’s your
second-best idea? What’s your
third-best idea? That adds
value.
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Contact Us:
RCleary19@gsb.columbia.edu
GRoberson19@gsb.columbia.edu
DZheng19@gsb.columbia.edu
Graham & Doddsville Editors 2018-2019
Ryder Cleary ’19
Ryder is a second-year MBA student. During the summer, he worked in Equity Re-
search at JP Morgan. Prior to Columbia, he was a Captain in the Infantry branch of
the US Army. Ryder graduated from the United States Military Academy at West
Point with a BS in Systems Engineering with a mathematics concentration. He can be
reached at RCleary19@gsb.columbia.edu.

Gregory Roberson, Esq. ’19


Gregory is a second-year MBA student and a member of Columbia Business School’s
Value Investing Program. During the summer, he worked in the Investment Banking
Division at Goldman Sachs & Co. LLC. Prior to Columbia, he worked as a corporate
attorney specializing in mergers & acquisitions and corporate finance. Gregory stud-
ied finance and economics at the University of Cincinnati and received both his JD
and LLM (Taxation) from Georgetown University Law Center. He can be reached at
GRoberson19@gsb.columbia.edu.

David Zheng ’19


David is a second-year MBA student. He spent last fall through this summer working
as a Consumer Analyst at Balyasny Asset Management. Prior to Columbia, he was a
Portfolio Manager at Peak6 Investments focused on single-stock volatility and special
situations. David studied economics, political science, and business institutions at
Northwestern University. He can be reached at DZheng19@gsb.columbia.edu.