Sunday, September 16, 2007

Pabrai Funds Meeting

I had the pleasure of attending the Pabrai Funds Meeting yesterday, which was simply just amazing in terms of the type of people that were all gathered in one place. I also took notes of Pabrai's presentation and wanted to share a few of the things from the Q&A section. The words in italics are my own.

Q: On Ipsco, why were the analysts so wrong?
A: With Ipsco, it is difficult to forecast the cashflow going far out in a cyclical business like steel, and no one likes to deal with uncertainty. But we were able to take advantage of that.

For reference, Pabrai's thesis on Ipsco was simple. It was trading at a market cap of 2.5 billion. It had 900 million in excess capital, and was projected to earn 650 million in free cash flow over the next two years, meaning 2.2 billion in cash by the end of that period. Though steel is highly cyclical, one can relatively easily forecast an industry 2 years out just by researching new supply projects and usual demand trends. Afterwards a gray area exists, but at that point it was a true Dhando situation- heads you win, tails you don't lose much.

Q: Why were you in and out of RailCar America so quickly?
A: There was a lot to like about the business. Though it is very cyclical, odds were pretty good this would be fairly profitable. We sold because it was very narrow, with its only product being rail cars carrying coal. Second, there was environmental and union issues. Finally, there was a chance that the expected replacement for coal cars wouldn't come around for several years. Probably a mistake to sell- we will see.

Q: How do you assess political risk in your framework?
A: Sometimes there is inefficient markets in how to deal with political risk. An example is with our Embraer in Brazil. The company was very cheap based on concerns about the currency, but that was just noise. Underneath you had a business that was the best at what they do and in a duopoly. They were the icon of Brazil, so the talent of the country wanted to go there, giving them a competitive edge. Also, Brazil wouldn't want to screw up an export champion.

There are several things I took from this. First was the idea of talent attraction as a competitive advantage. It's something that I never really factored in but has a lot of merit. Most likely, the best in an industry will attract those that are most passionate about that sector. One obvious example is Google. A second example- me! I was recently telling my family that if I could work right now, I'd jump at the opportunity to work with Exchange Bank of Santa Rosa because they're the best at what they do. And I'd like to think I'd be worth the cost.

The other thing I took from this is very important for any international investor. A unconventional test I like to put on any investment is the value-added. Well, with a company like Embraer, who is the best at what they do, there is definitely a lot of value added. There is also only one other competitor, and they sell their products all around the world. In such a situation, currency risk is really "noise". Any rise or fall in currency can easily work through the business to conserve profitability. Alternatively, I was recently looking at another wide-moat Brazilian company, but they sold only to customers in Brazil. In such a situation, currency risk is much more present- a decline in their currency wouldn't be offset by higher profitability on exports for a US investor like me.

Third, I'm guessing this original question was being asked with reference to Harvest Natural Resources, an American oil company with production in Venezuela. Again, currency risk seems to be less of a worry here, because they have a global product (as long as the government allows them to export that production). They're producing barrels of oils- and the value being created by that is practically the same whether its coming from Venezuela or somewhere else. This is something I'll be looking into.

Finally, I see the same thing with SFK. The product is sold mostly in North America, Europe, Asia. The fall of the US dollar seems bad, until you recognize that 90% of NBSK production is from either Canada or Europe. And there is also offsetting forces because I am a US investor putting money to work in Canadian dollars.

I hope some of these concepts were helpful.


Arpit Ranka said...

Thanks for sharing your notes!


Rick said...

Well done, thanks for the write up.