Rarely do you hear a fund manager talk about the ones they got wrong, however even the world’s best investors, including the great Warren Buffet, admit that a 60% success rate is about the industry standard. Regardless, when you are managing money on behalf of clients, it still makes you a little sick in the stomach when an investment underperforms to your expectations or externalities kick your carefully formulated assumptions to the kerb. Such was the case for me with Village Roadshow Limited.
In 2016 I bought Village after the share price fell from over $7 to just over $5 caused by the cyclical underperformance of the theme parks, accompanied with sector disruption in their film distribution business brought on by illegal downloading and low-cost media streaming. Conversely, their cinemas were producing record results despite vigorous competition from Hoyts who were doing their best to increase their market share in the sector. All things considered, the Company looked fundamentally very cheap. Trading at 5 times EV/EBITDA and paying a 5% dividend.
I saw a contrarian play.
I liked that the board (the Kirby Family) owned almost 50 per cent of the Company thereby having significant skin in the game and I expected the theme parks to benefit from a forecast fall in the Australian dollar, and the Commonwealth Games hosted in the Gold Coast in 2018.
Sadly, I was wrong.
Notwithstanding that there were some causes out of the management’s control (the Dreamworld Tragedy and questionable management of the Commonwealth Games by the Queensland Government), the reality was that the downgrades kept coming, the dividends ceased and the share price fell to $2. The bad news story reached a climax when the Company was forced to raise capital at $1.65 per share, a 77% discount to the January 2016 price when this story began.
As a fund manager, you have to understand that scenarios just like this one have happened before, and will happen again, but rather than dwell or make excuses I choose to reflect, analyse and dissect the investment and identify where the mistakes were made, so that I could leverage these experiences to make better decisions in the future. This particular reflection provided two key reminders:
1. The best laid plans need the right people to execute
Irrespective of the economic environment, even the best corporate strategies need the people behind them to execute them effectively. A management team that is focused, transparent, reliable and diligent will in most circumstances, outperform their peers in both good times and bad. When we invest in a company, we are essentially employing the management to look after our money, to make decisions every day that will enhance the value of the business.
Examples of businesses with quality management are Boral, Bluescope Steel, and AMA Group. In all cases the management are passionate about what they do, understand their respective businesses inside and out and this is portrayed every time they address their shareholders. Needless to say, I own shares in all of these companies.
2. Take the time to experience the business from the customer’s perspective
Such a simple rule but one that is often overlooked.
Fund managers can sometimes get too involved with the accounting, measuring performance on the financials alone and neglect to consider that it might just be good luck or a booming sector that gives the appearance of a high performing business. Perhaps it has simply not yet met a worthy competitor. As we embark on an age of disruption, customer experience is often the catalyst that will see an incumbent’s long-standing customer base, slowly venture over to the up-and-coming, especially in our world of social media and interconnectivity (where good news travels fast but bad news travels faster and further). It often isn’t long before the rest of the customer base is aware of the better option and decides to make the move also.
An example of this phenomenon is AfterPay Touch. The buy now, pay later app has a simple, easy and efficient customer experience that for many is a perfect alternative to high interest credit cards with complex terms and conditions and onerous application processes. AfterPay has return over 200% this year and is one of the best performing stocks on the ASX despite trading at a multiple of over 10 times that of the banks it is pinching its customers from.
The same principle can be applied when deciding whether to pay a premium for a company that has the appearance of a high margin, recurring customer base. Although this might currently be the case, if the customer experience is poor you can bet your last dollar that other companies will try and coax away that customer base and if they are disgruntled, it won’t take a lot of effort. Before you know it, the incumbent is trying to win back their customers in the only way they can… with a lower price. It’s not always easy to experience the offering from every company in your portfolio, but it is worth the effort.
So, reflecting on the case of the ‘Village Roadshow Mistake’ it’s always painful to admit when you are wrong, but the reality is that as humans we are all bound to make mistakes. What defines us is not the mistakes we make but how we learn from them and apply that learning to what we do going forward. In this case, I have been reminded the utter importance of these two rules and even the most attractive fundamental valuation means nothing without quality management and exceptional customer experience.
Belvedere Share Managers Pty Ltd AFSL #330181