David Samra, Managing Director of Artisan Partners and lead portfolio manager of the Artisan International Value Fund, explains why ABB should split into two separate companies, why he expects further divestitures at LafargeHolcim and what he likes about Novartis, UBS, Nestlé and Richemont.
Q1 hedge fund letters, conference, scoops etc
David Samra is one of the most influential investors in the Swiss stock market. He is the lead portfolio manager of the Artisan International Value Fund which has approximately $20 billion in assets under management and a portfolio of around forty holdings. Among his core investments are Swiss blue-chip companies like ABB, LafargeHolcim, Novartis and UBS.
Oftentimes, Mr. Samra bets on companies where he spots potential to create value by focusing on the businesses’ core strengths. ABB is a classic example: «We think ABB is an unwieldy conglomerate that needs to be slimmed down further,» says the experienced value investor in an exclusive interview with The Market.
In his view, the transaction to sell ABB’s power grid business to Hitachi for $11 billion is only the first stage in a fundamental reorganization of the Swiss engineering group. «Now, we would expect that the logical next step should be a further division of ABB into two or maybe even three separate companies,» Mr. Samra says during a conversation at the Artisan offices in San Francisco.
He also has a clear opinion regarding the turnaround of LafargeHolcim: «LafargeHolcim is earlier on in the process of simplifying itself than, let’s say, ABB,» he states. After the divestiture of the Southeast Asia business, he expects the cement giant to follow through with further adjustments of the organizational structure.
Mr. Samra, international stocks had a smooth start into the year. Now, the ride is getting bumpy. What is your outlook for the second half of 2019?
At Artisan Partners, we don’t try to forecast the stock market. The market is driven by an enormous amount of liquidity and overlaid with the emotions and motivations of people. Also, there are unthinking machines like ETFs and algorithms which trade without too much attention to price.
So what is your investment strategy?
What we focus on is the value of securities that are trading in the marketplace. We look for four key characteristics in a company: First and foremost, it has to be undervalued. In addition to that, it has to be a good quality business with a strong balance sheet and a management team with a track record of building value over time. This intrinsic value of a business doesn’t move around nearly as much as the stock market. As value investors, we take advantage of these emotions when they represent some sort of inefficiency, either on the upside or the downside.
How do you invest in this kind of market right now?
While we don’t know what’s going to happen in the stock market, we generally like volatility. Right now, we actually see value. Since we started our fund in 2002, we measure the aggregate discount to the intrinsic value of our portfolio on a daily basis. At its widest, this discount was 40 to 45% and that was in the middle of the financial crisis. The narrowest discount we ever experienced was at the end of 2017 when it was close to 5%. Today, the discount is in the mid-20s which gives us a good opportunity to compound our shareholder’s money.
Almost one quarter of your assets is invested in Switzerland. Did you also spot new opportunities in the Swiss stock market?
No. We have not purchased any new securities in Switzerland.
One of your top positions is ABB. What do you like about the Swiss industrial group?
We got involved in ABB several years ago upon the recognition that most of its businesses were – and still are today – operating at margins that are below their peer group. At that time, the management team was new and embarking on a restructuring program which would start to repair the operating profitability. Also, the company has a clean balance sheet and leading positions in each of its segments. That would imply that ABB should achieve at least peer group operating profitability. Given their leading positions, they should be able to achieve even higher than peer group profitability and better growth rates. Unfortunately, over our holding period the management’s execution has not been good, but I think ABB is finally headed in the right direction.
In a recent transaction, ABB sold its power grids business for $11 billion to Hitachi. What should be the next step for the company?
Many years ago, we started communicating directly with the board of directors, helping them understand the benefits of focus. There are many empirical studies indicating how inefficiencies creep into an organization when it goes from a focused business to a conglomerate like ABB. We spent months going through ABB’s product list and sent this list to the board of directors. We weren’t sure that they knew of everything the company manufactures. People think of ABB as a factory automation company selling high-end robots and software systems. But ABB also sells things like giant ship propellers, office furniture and several products through Home Depot like exit signs. That’s why we think ABB is an unwieldy conglomerate that needs to be slimmed down further.
Why do you think a trimmed down ABB would achieve a better operating profitability?
Out in the marketplace, there is ample evidence that this works. You see a larger and larger trend: Philips for example many years ago sold PolyGram Records and their semiconductor business NXP which is now listed as a $30 billion market cap company. Siemens, in the same industrial space as ABB, now starts to slim down as well. ThyssenKrupp is moving in the same direction. The management is not executing well, but they’re attempting to slim down the company slowly but surely.
So what should ABB do next?
Empirical evidence shows that when you take a large conglomerate and change the structure to enhance focus, the benefits are significant: You get better profitability and better growth rates. Incentives are more aligned and there are fewer resources wasted. We’ve sent these empirical studies to ABB’s board now twice along with letters indicating that we think that a stronger and growing company is far better for the shareholders, the employees and all the stakeholders than a company which is inefficient, has low levels of profitability and poor cash-flow generation.
Where do you see opportunities to improve ABB’s structure?
The divestiture of the power grids business is a first step in that process. We’re encouraged by the internal changes that have been made by taking down the matrix structure and aligning the incentives of each of the remaining four units. Now, we would expect that the logical next step should be a further division of ABB into two or maybe even three separate companies. Two separate companies make sense rather than three, but we won’t really know until these product lines get narrowed down and we start to see the benefits of focus.
What should a further division of the group look like?
Electrification products and factory automation: Such a split would make obvious sense from the outside of the organization. I’m not sure if we need a third step. The factory automation piece should be kept together. Then, within that business, a more focused management will start to prioritize amongst the products where ABB has a distinct competitive advantage. So you will find things like office furniture starting to be divested.
Today, ABB’s operating margin is around 8.3 to 8.4% on an EBIT basis. What kind of improvement are you expecting after a split-up?
ABB’s business units already have some advantages in terms of scale and product range. I would expect that each of the remaining divisions should be able to improve their EBIT margin at least 200 basis points from today’s levels.
Headed by Peter Voser, ABB’s board of directors is looking for a new management team. What qualities are needed from the future CEO?
I don’t have a wish list. But ABB’s board of directors is well equipped to find somebody who is able to improve on the execution of the last management team. The prior management was very strategic in its orientation but less focused on operating the business in a profitable and growing way. That’s why we think we need less strategy and more operating capability.
Read the full article here by Christoph Gisiger, The Market NZZ
