#57 Behind Edelweiss Capital
An interview by Capital Employed
Today's post brings a refreshing change. As Europe swelters in the scorching summer heat, I thought it's the perfect time to bring some lightness and share an engaging interview conducted by Capital Employed back in April. Consider this interview as an open window through which you can gain a deeper understanding of the person behind this substack on a more personal level.
Lastly, I want to extend my warmest wishes to all of you for an extraordinary summer filled with joy and unforgettable moments.
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Note: This interview was originally conducted by Capital Employed and is shared here with permission from the interviewer and original author. I highly recommend visiting his Substack, where Jon shares insightful interviews with investors and compiles engaging investment write-ups from the community every 15 days.
Hi Javier, thanks so much for taking the time out to do this interview.
Can you please tell readers a little more about your background, how did you get involved in investing?
It's a pleasure, Jon. I could say that my background is somewhat of an outsider in the world of investing. I am an aeronautical engineer by training and began investing after saving some money while working for Airbus as an expat in France.
Before that, during my university days, I was interested in the stock market and did some things, but nothing really worth mentioning.
After nearly a decade working on the development of various aircraft and dabbling in startups, I decided to go all in. I left my job, and pursued my passion.
During this entire time, I had been reading and learning in a completely self-taught manner, and obviously making all the mistakes that come with it.
So I quitted, I completed CFA Level I, started a small M&A boutique with other partners in Spain, and finally, about a year ago, I joined a Swiss family office.
I really enjoy reading your substack. What is Edelweiss Capital Research?
Glad to hear it. When I decided to launch Edelweiss, it was simply a way for me to order my thoughts on different topics I find intriguing and to further clarify my decision-making process, but also kind of a marketing/personal brand tool.
Edelweiss Capital Research is a weekly newsletter where I discuss various topics related to investing. Substack is full of investment theses, and this is great! But I aimed to discuss other aspects that I found more important.
Topics like the fundamentals of value creation by companies, how to assess and evaluate a company's acquisitions, reflecting on management team incentive systems, and so on.
All of this is combined with reviews of the books I read, some comments on different companies. A hotchpotch of topics I want to dig in.
I obviously don't publish anything directly related to what we're looking at in the office, at least not about small-mid caps in which we might take a position at some point.
What type of businesses do you like to invest in?
I like to invest in undervalued, well-managed, good businesses :) I think every fundamental investor is looking for the same thing, right?
But there's no perfect business, and usually, the closest ones are almost never attractively priced.
So for me, in the end, I narrow it down to three basic categories:
Exceptional management teams that have a strong understanding of capital allocation to generate shareholder value. Ideally, founders or managers with an owner's mentality and compensation incentives aligned with value creation.
Business quality: businesses with the ability to reinvest profits at high returns on capital.
Prices below intrinsic valuation and with visibility of terminal value.
Now, these three characteristics rarely occur together at the same time, and each investment is a trade-off between the three. Each investor then gives more weight to one over the others, which is why there are so many different opinions in the market.
For me, the management team is the most important in an investment decision. In the end you are providing capital for them to allocate it.
In fact, if there's any red flag there, it's simply a no-go, regardless of the quality of the company they manage or how cheap it is. Next would be business quality, and lastly, the price.
Why this order? It's quite simple. The management or owner rarely changes in good companies, while the price changes every minute, and you never know when Mr. Market may offer you an opportunity.
Where are you finding good ideas at the moment? Is there any specific sector, industry, or country that you are currently finding good value in?
I think there is a lot of uncertainty in the markets right now, which in turn creates many opportunities. COVID-19 has caused disruptions in habits, supply chains, monetary policy, and many other aspects for which the market has not yet fully stabilized, leading to significant disparities between value and price.
I believe this uncertainty is clearly exemplified in Europe, particularly in the UK or Eastern Europe, and in China. The latter case is striking.
There are high-quality companies in China, outside of regulated industries or major tech firms, with management teams that consistently reward shareholders and boast stable and growing businesses trading at ridiculously low multiples.
I understand it might be controversial for many, but I still see value and an adequate risk-reward opportunity in some cases.
If we talk about industries, there are sectors that benefited greatly from COVID-19 or monetary expansion that are now facing demanding comparables, and the market is discounting sharp declines.
I'm thinking of logistics companies, recreational vehicles, or alternative asset managers, just to give some examples. I believe there are quality businesses in these industries that could be interesting to look at.
But you don't have to rack your brains too much. In November, we had Meta trading at less than $90 or Constellation Software at CAD 1800.
The larger your universe of companies, the more opportunities for irrational market valuations will arise.
Can you talk about two specific companies in your portfolio you're bullish on? What was the thesis for investing?
My top three positions make up a huge chunk of my portfolio. I don't think it will be a surprise to anyone who has been reading my Substack. They are Constellation Software, Brookfield, and Amazon.
The investment theses for each, despite being completely different, boil down to the same principles.
All three are companies with a track record of being well-managed, with great runways to reinvest all the cash flow generated back into the business, each with its own nuances, and trading (or having been traded) below what I consider intrinsic value.
Instead of focusing on the specific positive aspects of each company, which are many and well-known, I find it more important to concentrate, be aware and monitor the risks they face.
💡 Constellation Software (CSU)
The mighty Canadian company continues to do what seemed impossible, which remains its greatest risk – not being able to deploy FCF at the high returns to which we're accustomed, causing multiple compression. I discussed this in greater detail here.
💡 Brookfield (BN)
The alternative asset management space is quite complex in its operations, with assets passing from one fund to another until proceeds are realized, etc. Confidence in management doing the right thing for shareholders is necessary, and this doesn't come easily.
Brookfield and Bruce Flatt have had a strong track record. The industry has had many tailwinds in the last years, growing AUM at high rates and securing capital for future years, which will generate attractive fees. Most of the returns in the upcoming years should be locked and certain.
However, rising interest rates would likely reduce returns for LPs in different vehicles that are already invested (since many are highly leveraged), making it more difficult to attract capital for future funds, especially when other instruments offer decent yields at the moment.
There is also the topic of Brookfield Property Book (Real Estate assets) whose book valuation causes discussion in the market, etc.
💡 Amazon (AMZN)
What can we say about them?! Concerns about Bezos-Andy Jassy succession, huge CAPEX cycle, cost control problems, overstaffed, AWS slow-down, and many other.
There are many challenges to the company, but again, that's the nature of business, capitalism, and a company that constantly tries to innovate and reinvent itself. I wrote about my general views on Amazon here.
It may seem like I'm bearish on all three, but in general, I don't really like listening to people selling a business and telling you the good things.
I can see the good things in how the company has evolved over the last 20 years! Tell me about the problems and why you think the company will pull through and continue to create value.
In my case, I believe that Constellation will still be able to deploy capital with returns exceeding at least 15%, and despite potential multiple compression, the company will continue to offer attractive returns for shareholders.
Brookfield may experience a period of pressure with high-interest rates, but interest rates will return (whenever it might be) to lower levels because there is no other structural alternative, and the long-term trends in the alternative asset management industry will continue to provide interesting returns for institutional investors.
Lastly, if Amazon keeps focusing relentlessly on serving the customer, innovating, and focusing on long-term FCF generation, I think everything should be fine.
The rest of the portfolio (for a total of 10-12 positions) consists of a couple of Chinese companies (between 10-20% of the portfolio), and some smaller companies that I still consider comply with my 3 requisites, but offer higher expected returns because they might have potential higher growth rates or I consider them heavily undervalued by the market.
Who is your favorite capital allocator?
I don't want to sound cliché, but what Mark Leonard has achieved is truly remarkable, not only in terms of results but also in his approach.
He has managed to bring along employees and acquired businesses with him in their success.
He has ensured that capital is deployed in the most value-accretive manner while maintaining a lean and decentralized corporate structure, focusing on culture, incentives and individual accountability.
Furthermore, he has demonstrated the deepest respect I have seen in a CEO/Chairman for his shareholders. When shareholders asked him to buyback stock, he answered:
Buybacks of under‐valued stock feel to me like insiders preying upon their weakest shareholders using superior information.
You can agree or disagree, but to me, this is ultimate respect. A nice quality if I am entrusting capital.
Thanks once again Javier for the interview. Where can readers find out more about you?
Thank you for the opportunity. You can contact me anytime at:
Disclaimer
This interview is for informational and educational purposes only, and should not be seen as investment advice. Please do your own research before thinking of investing in any company mentioned.
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Good interview.👍🏽
Fun read. Thanks!