Sequoia Fund Investor Day: Full Transcript

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

but there is also a little bit of an aspect of great merchandising and great leadership at the top.

You also say, well, it is countercyclical … gosh, TJ has done awfully well in the UK. It is doing really well in Germany. The company’s Canadian division, Winners, already had the highest margins in the company when Carol took over, and the chain is pretty much built out. So there is not a lot of room for improvement. But the company is expanding Marshalls into Canada to complement Winners. The home goods business has been a home run. All parts of the company are functioning at a really high level. So I would say the economy helped TJ; it did not hurt the company as it did many retailers. But leadership also makes a big difference, and probably more of a difference. And I think that TJ is just a business that is run by the perfect person to run the company. That helps too.

We would be more concerned I think … Carol is 60, and I am hoping she decides to work to 70 instead of 65 because she will be tough to replace. It is a good company, and even there, Carol has invested so much in training; the management team below her is stronger than it was by far ten years ago. This is one that we have known for fourteen years, so we really have some history with it. But the management team is the strongest … or as strong as it has ever been.

At this point, the internet is a greater threat than it is an opportunity. Whenever competitors can enter a business easily, it is not good for the incumbent. And we are keeping an eye on these flash-sale websites. But the treasure hunt aspect will be difficult to replicate on the web. Much of the appeal of the physical store is finding that one dress or jacket that is available in one or two colors or in one or two sizes. TJ itself did re-launch its website last year, but management is developing it slowly and is being careful to make the merchandise offering and customer experience different from that of the physical store. In addition, in 2012 TJX acquired Sierra Trading Post. It had three outlet stores at the time, but was mainly a web-based business specializing in outdoor sports apparel and footwear. TJ is planning to open a few more stores to see how well that format works off the web.

Bob Goldfarb:

The interesting thing is that Ross Stores, which we visited at the same time we bought TJX, we did not buy. But Ross has done every bit as well. The

Nordstrom Rack is a lot smaller than TJX, but it seems to have some traction and quite ambitious expansion plans.

David Poppe:

Yes, it is a pretty good industry, and I would say the structure of the industry is also … it is not an easy business, because you have seen a lot of other smaller people fall out. But the two dominant ones have only gotten stronger. The incremental cost to produce your next piece of apparel is very low; so people tend to want to overproduce. As long as you have a good outlet for that production, it does not hurt you so much. Ross and TJ make really good homes for excess product. They allow the manufacturers to produce more than they might otherwise.

Question:

You once opened Sequoia and then closed it. At what point would you ever open it again?

Bob Goldfarb:

We reached a new peak level of assets and we want to make sure that we can manage at that level of assets as well as we have managed at lower levels of assets in the past. We do not want our universe to be more restricted. We want to be able to buy companies with market caps of $3 billion, $4 billion, $5 billion, and have them be meaningful to our performance. We would give that up if we had a significant infusion of funds. So we are going to stay closed, and we think that is best. All the constituencies seem to like it. Our investors hopefully will benefit from the flexibility that that gives us. Our analysts are always coming to us with ideas that have market caps of $3 billion to $4 billion to $5 billion, and so I think they would not like us to say, “Gee, we have grown assets to a point where … it is a great idea, but we have grown assets … it really does not make sense to pursue that idea.”

Question:

I was just wondering if any of you can talk about what is going on in the Ukraine and whether any of the holdings in the fund have any exposure or opportunities involving Russia?

Bob Goldfarb:

The Ukraine itself is just too small to make any difference whatsoever. If you are asking about Russia, a couple of our companies do have participation there. Mohawk is one, where they bought an Italian company.

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

Terence Paré:

Mohawk bought Marazzi, and it has a very successful business in Russia. One of the interesting things about the Russian flooring market is that after the Soviet Union collapsed, property was transferred to the citizens, and the houses that they lived in, because they previously did not own them, were in a terrible state of disrepair. The most recent statistics out of the government, and I am not sure how reliable these are, but something like 66% of the residences in Russia need very serious remodeling — which would include flooring, obviously. But the business, while significant for Marazzi, is not terribly significant within the whole of Mohawk. When I spoke to the people at Mohawk about the situation in the Ukraine, their Russian salesmen were actually pretty happy because they could now do business in the Crimea.

The other thing to remember about the flooring business is that it is not a strategic industry for Russia. It is not an oil company or a natural gas pipeline or something like that. Marazzi has been in Russia for over ten years. It is run by Russians. They are scattered all over the country. They are basically small business people. You never know what could happen in Russia, obviously. But Mohawk is not terribly concerned about any ill consequences, and I think management is being reasonable about it.

Question:

Back to Berkshire. It originally did the repurchase at 1.1 times book, and now he is gone to 1.2, do you have any comments on that?

Jon Brandt:

I think he was being too cheap when he said 1.1. He realized he was not going to get any and 1.2 is still enough below intrinsic value that it is accretive enough for shareholders. I think he was too wide-eyed when it traded there just for a little bit. I do not think he loves buying back stock, but he is starting to realize that it is good to have yet another way to build value. I think Berkshire is going to do it more if the stock trades there. I think he is reconciled to it.

Question:

What is book value?

Jon Brandt:

Book is almost $140,000, so $168,000 would be the buy price. It is interesting, it was a little below $140,000 at the end of March but the Graham Holdings deal was not closed as of March 31. When

that deal closes, the deferred taxes associated with that position go away. So on a pro forma basis that would help just a little bit. I do not know if that would have gotten book to $140,000 at March 31^st, but most likely it is above that level today.

Question:

You said something about buyback right now, and I have heard a lot of praise of leadership of a number of companies through the day. Can you speak specifically with respect to IBM and its leadership, and whether you have the confidence in the leadership that it will go through with the fair amount of changes that are taking place in information technology? IBM had been through that struggle in 1990s. Does it have the bench strength, and is it doing the right things?

Will Pan:

One thing that is interesting is if you read Lou Gerstner’s book, and if you observe IBM through the years, it has been pretty well aware of technological shifts and has predicted many things. I have talked to people recently who tell me IBM had done the pioneering work in 3D printing, for instance, and it sold those patents to what became Stratasys when IBM realized that that business would be very slow to take off over time. IBM did pioneering work also in speech recognition. So it has been on top of a lot of the technological trends over time. It has done a fairly good job also of mapping and trying to understand what the opportunity set is on a commercial basis — how big the business could be and when the business could take off. It is fairly sophisticated in that, and its research department is great.

What was lacking and what we focus on now is whether IBM is properly grabbing hold of the things that it observes and invents. I think since Gerstner really came in and reenergized that company, it has done a much better job of recapturing the pieces that were not proprietary. It used to be very much a mainframe-focused company and now management has realized that it has to participate in open innovation. You saw IBM’s support of Linux, you see its support of OpenStack, and you even see IBM opening up its chips for its open power initiative, which is how IBM got Google to be interested in the technology. So we have a fair amount of confidence that out of the technology industry, IBM has a good grasp of what is coming in technology and that it could move faster. But IBM is moving pretty quickly

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

in terms of getting ahead of some of these new changes that are coming down the pike.

Question:

In the annual report you say that the total return for the Sequoia Fund was 34.6% in 2013. What is it so far in 2014, and what are your goals for the balance of the year?

Bob Goldfarb:

We never set goals for the year. We would often be far off in either direction.

David Poppe:

I think we are basically flat for year-to-date as of last night. I do not have it in front of me, but we are flat for year-to-date, and the market is up maybe 2%. So we are about two points below the S&P 500 Index year-to-date.

Question:

Just going back to Valeant, you mentioned it is at the higher end of some of your implicit thresholds of leverage. I am curious what would cause you to sell or resize that position?

Bob Goldfarb:

If it became overpriced.

Question:

Would you please comment on the Graham Holdings, your insight into Warren’s deal, and what you think of it?

Jon Brandt:

I looked at it briefly. It looked like a good deal for Berkshire in that Berkshire got to offload a position that I do not think Warren was excited about going forward and that had a large built-in capital gain. Plus Berkshire did not have to pay tax on the gain because of this bizarre cash-rich split-off tax regulation, which does have some logic behind it. The ability to include cash is a weird little wrinkle. The cash is the boot, as they call it. If you are trading two assets and they are of slightly different values, you can add some cash to make it equal. The Washington Post company — it is now called Graham Holdings — also avoided taxes because it disposed of its Berkshire shares, which Berkshire got to effectively buy back at what might seem like a valuation of more than 1.2 times. But whenever you are trading assets, you just have to look at what you are trading. So I would not say that he violated the 1.2 multiple for a buyback with that. Berkshire got a TV station which it may or may not have been really

interested in, but which was necessary to make the pieces of the exchange equal in value. They both avoided taxes. I believe Berkshire got more value than Graham Holdings did because Berkshire had almost a zero cost-basis on its Post shares, whereas the Post had a much higher cost basis on its Berkshire shares. But it probably works out pretty well for both companies.

Question:

I was at the Wesco meeting where Charlie talked about not wanting to buy asset-intensive businesses. As I heard it, he was talking about the customers of a Ritchie Brothers, capital intensive, highly cyclical low-value businesses. My two cents is there is absolutely no change in investment philosophy. The capital intensive entity that he is setting up at Berkshire is in regulated businesses with visible, attractive returns. With regard to Berkshire in the future, I do not worry about an idiot manager. But I do worry about an uninformed regulator. So how do you think about the regulatory risk?

Jon Brandt:

It is a risk, and I do not want to be flippant. But I will try to be brief here because we are running out of time. MidAmerican is in maybe eleven different jurisdictions. It has transmission in Canada, transmission in the UK, utilities in Iowa, Washington State, Utah, Idaho, Oregon, Colorado — the list goes on and on. In the United States you have one regulator per state. So at least there is some diffusion of risk in the utility business. Could they change the rules at any time? Sure.

Bob Goldfarb:

I would just say it is a trade-off. If you want a business that is absolutely essential and it is a monopoly or duopoly, you are probably going to have a regulator. So it is a trade-off. He wanted businesses that had essentiality and durability, and the price for those businesses is the risk of regulation.

Question:

I’m wondering if you