Sequoia Fund Investor Day: Full Transcript – Page 7 – ValueWalk Premium
Sequoia Fund

Sequoia Fund Investor Day: Full Transcript

discretionary and that the CEO and the CIO will have to deploy going forward. There is a lot to be done in utilities. The nation needs more transmission lines; it needs more environmentally friendly power generation, et cetera. And the railroad is a good place to put money for the country because railroads are very fuel efficient. I would not say the returns are guaranteed because regulators have to be reasonable. Warren is making a bet that the regulators will be reasonable because the country does need that investment. But Berkshire is far from being an idiot-proof company.

Stephan van der Mersch:

Just to echo Jonny's point, as somebody who tries to find investments in China, there are many reasons — a lot of good reasons — to not try to invest in China. The standards for corporate


Ruane, Cunniff & Goldfarb Investor Day St. Regis Hotel, New York City – May 16, 2014

governance to get into the Sequoia Fund are really, really high. And I cannot think of many examples of companies in China, Chinese companies, that get anywhere near that. You can invest in companies with great corporate governance in the US that invest in China and you can get the Western quality corporate governance. It is a really tough place to do business.

I am not a macroeconomist, but I have been going to China for about ten years now. The economy there looks like at least half the growth is based on building new buildings. I would be on a bus tour visiting a company and we would be in a rural area, 20 to 30 miles from a city, and you would see a 60-story skyscraper coming out of a farm field. It is easy to look through the press and see this kind of thing all over the place. All this is financed with bank loans. You look at the project and you just do not see how the interest is being paid. I wonder what happens when the loans cannot get paid. I used to think that the political system would be pretty resilient in the event of an economic downturn and now I am a lot more skeptical of that. That said, there are certain places where it is very interesting to keep on looking. The challenge always is finding people you can trust.


Talk about an idiot-proof company, MasterCard — do you have any comments on its current growth projection and also the valuation?

John Harris:

I never thought about this until you just called it idiot-proof, and I do not know what it means about me that I am the guy who covers it. What can I say? It is a good business. It has given pretty much the same guidance, financial guidance, for a long time now. The guidance is very attractive. It implies earnings per share growth in the high teens or maybe even approaching 20%. I think it is very realistic. So it is a high growth business. The market appreciates it as such.

When we first bought it, there was a bunch of clouds swirling around it and it did not trade at the multiple it trades for now. In retrospect we paid maybe thirteen times the earnings the first year out of the gate after the IPO. Now it probably trades for more like 22 or 23 times earnings. Different people can have different points of view on the reasonableness of that or the attractiveness of that. But certainly it is a high growth business. It is deserving of a high valuation. I would say that the couple of big issues that have always been in focus for us in

terms of business risk at MasterCard — with each passing year, the news just seems to keep getting better. The breaks just really go MasterCard’s way.

There was actually news that there were regulators in the EU who would like to see the interchange system banned entirely, which if there had been a news item to that effect five years ago, I shudder to think what the stock would have done. But people have learned over time that the company is so amazingly resilient to these regulatory challenges and challenges to the business model that the stock just completely shrugged that news item off, which tells you something. So I think we feel okay about it. Whether it is an attractive valuation or not, you have to make your own determination.


Both Rolls and Precision Castparts are in the aerospace supply chain. I am curious how you think about the two. Which is a better business and which is a better long term investment?

Greg Steinmetz:

Which is better? We hope for greatness from both. Arman, you argue Rolls, I will argue PCP. Rolls and Precision are in the same industry, which is a fantastic one, commercial aerospace, because of an eight-year backlog we have now on jets. But unlike Rolls, which is making multi-billion-dollar bets when it sells an engine and has to wait for the cash, Precision gets hard money up front when it sells a part.

Precision Castparts, I really like the management there. Mark Donegan is first rate. He thinks about every penny and Mark is great at identifying adjacencies and interesting companies in those adjacencies to acquire. He has a great track record of taking these acquisitions and really milking them for all they are worth.

Why I think Precision can keep growing is that it generates — this year it will be close to $2 billion of cash, which management has shown it has been able to invest at a 15% return. The question is, can Precision keep finding acquisitions. The big one they did a couple years ago, Timet, a $3 billion acquisition — you could spot that one coming from a mile away, or in our case, 3,000 miles away, thank you very much. Precision closed on a $625 million one just last March, but I do not know what is out there now that has the kind of scale that Timet had.

Management says there are some and the team is always looking, but I would say my biggest concern is whether Precision can keep finding these


Ruane, Cunniff & Goldfarb Investor Day St. Regis Hotel, New York City – May 16, 2014

acquisitions. Once Precision gets them, I have no question that its managers can make them great. What Precision has done with Timet and most everything else it has bought since we have owned it gives me a lot of confidence. So my concern with Precision is just whether management can find the deals. If Precision does not, we still get organic growth because the 787 is going to go from seven or eight builds a month last year to ten this year, and maybe even higher. We have got these new narrow bodies coming on, and they are increasing the build rates of those. Because Precision is so good at improving efficiency, it has a better cost position than its competitors, and the company is able to pass that on to customers and win market share.

Arman Kline:

I would just add — they are in the same industry, but they are leveraged to two different parts of it. Over the long run, PCP has more leverage to the new build. Because of the unusually large number of engines that Rolls will deliver in the next few years, it is tied pretty tightly to the new build market for now, but once those engines are placed in service, Roll’s earnings should hold up better if and when demand for new planes slackens. Rolls’s service contracts run for ten to fifteen years. But the other thing with Rolls is that it is now buying Tognum, which puts the company more in energy systems, making it more diversified. It is not so civil-dominated a business anymore. And it is in marine whereas PCP is more levered to aerospace.

David Poppe:

I would just interject one thing. I agree with everything Greg said. But Mark Donegan is not milking the assets; he is sweating the assets. He is really good and he is driving these businesses harder than people thought they could be driven. Not to overuse the comparison, but I think these 3G guys running Budweiser would really appreciate Mark. He is a very good CEO.


I think last year you commented on QinetiQ, the UK company run by Leo Quinn. Since we are talking about the management Hall of Fame today and different individuals, I am curious — when you made the investment a couple years ago, given that it was primarily in the defense industry and the growth opportunities at the time were challenging to say the least — how has the company performed, and what do you think the future looks like in light of the industry it is in. And how Leo is doing?

Arman Kline:

I do not think anyone here would argue with your premise. Yes, defense looked challenging, and I think it turned out to be even more challenging than Leo or we expected. That said, he has done just a wonderful job with that business. He sold off the US assets, admittedly for less than all of us would have hoped. But he has turned the UK asset into a grower with a double-digit margin. He is generating very good returns on assets. And he has got some technologies in that pipeline.

QinetiQ was named after the character Q in James Bond, the story goes, because it was supposedly the division that created special gear for the UK military. It continues to have some unique new technologies. The company has a couple that Leo has talked about publicly. OptaSense is one that uses fiber to map out all kinds of things. You install the fiber along oil pipelines to see if anyone ever taps into it. It is being used now in down-hole fracking. It is used to monitor international borders. It has the potential to be a very large business and it is non-defense. The company is also getting into using systems to monitor power line and power grid usage with another unusual technology. So I think that Leo has done the right thing. As he would say, he has put all the chips on the table. The roulette wheel is spinning, and we are going to see what happens with those technologies. And he has cleaned up the core asset very well.


Thank you for your work. I do miss seeing Bill and Rick up there. I wonder if you could talk about the compensation system. I do not think that has been covered before — how you keep the veterans interested and how you keep the new guys incentivized.

David Poppe:

Everybody except me is massively overpaid.

Bob Goldfarb:

Very good. That's it.

David Poppe:

We have a great team. We do not spend a lot of time benchmarking against other firms. We treat the analyst track as a career. I think a lot of other firms do not do that. We want someone to be a world class stock analyst and want to do that for the rest of his career. For people who do a good job, we pay really well. So that is part of it. Without getting into dollars, there is a psychology there. Some of the


Ruane, Cunniff & Goldfarb Investor Day St. Regis Hotel, New York City – May 16, 2014

really good firms that I know and good people that I know, their analysts are all very young and it is up or out. We would like to have people be world class stock analysts and do that job for a long time and know their businesses better than anybody.

We are lucky that we have them. This is an incredibly strong team and hopefully that comes through to all of you. If you are a certain kind of investor and you want to be a value investor and own long term positions and work at a place that has a concentrated portfolio of best ideas, this is a pretty good home. We have a lot of people who do make it a career. We have really low turnover. And we empower — there are some younger people over here, Rory, Will, Saatvik, you have seen today, and Stephan — pretty young people who are really empowered in our system. They have real responsibility. They are not doing spreadsheets and supporting Jonny and Greg; they are doing the work. So that counts for something too.

We are fortunate we have got some really smart people with a lot of options. But they get more responsibility maybe with us than they would have somewhere else. That all comes together. Pay is part of it. Responsibility is part of it. Being on a winning team is fun for everybody. And I do not want him to get a big head, but Bob is a pretty good boss. He empowers people and he takes your input very seriously. So it really hopefully — they will all shake their heads, it feels like a team. You feel like you are on a winning team and you are making a contribution that is highly valued by the CEO.


In the Berkshire annual, Warren mentioned how after his passing, he is going to have his money go into Treasuries and into the S&P 500. Does that in any way worry you? Why not keep it in Berkshire as opposed to diversifying into the S&P?

Jon Brandt:

I think he was just talking about a trust for his wife. I think he said that the money that is going into foundations is going to stay in Berkshire. Clearly the comment raised a lot of eyebrows. I was asked to stick to questions about the noninsurance businesses, but I kept getting e-mails from people, “What's this about the S&P 500? Is Berkshire not going to outperform it?” I think he was just looking for a simple solution for his wife, and I would not read too much into it.

Bob Goldfarb:

It is very interesting that someone who for many years preached the gospel of the inefficiency of the stock market wants to invest in an index fund. Clearly, he thinks that the world has changed since he and his friends in Graham and Doddsville were running modest amounts of money and trouncing the index to a world where a lot more very intelligent people running large sums of money are trying to beat the market.


Can I ask you to comment on the remarkable success of TJX? Do you think this is countercyclical or is it secular? Does the web represent an oncoming freight train?

David Poppe:

That is a really good question because the performance has been so strong since 2008. So it does make you wonder if it is a countercyclical business. At the same time, the performance was pretty darn good for the seven years prior to 2008, with one or two hiccups. So it is hard … I think TJ was definitely helped by the fact that the consumer needed to focus harder on value. But as the economy has gotten stronger, it has not lost any traffic, has not lost any sales. And TJ, interestingly, has improved the mix subtly over the last three or four years. There is more high-end product in the store, which suggests there is a wealthier shopper in the store, too. So this is not strictly a Walmart-type story of a middle-class customer who is desperate


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