I Trust You So Much That We Should Document What You Just Said - Rental Agreements

Several years in corporate banking taught me the importance of the terms and wording in credit agreements and other legal documents. This is especially so when you have lawyers being paid $750/hour (which is cheap compared with our American friends!) to find ways to use agreements to one party’s favour or detriment. And much more so in the case of distressed companies, where decisions are sometimes hastily made based on verbal agreements, which may end up falling apart when papers are actually drafted.

You don’t want to take the idea of documenting everything too far, though…

But important items – particularly points that can foreseeably be disputed – should be documented.  

When I moved to the UK this fall, I quickly realized how inefficient stupid backwards different the process is compared with Canada. In London, it is common that landlords hire a letting agent and pay them commissions of ~10-14%+ of the entire lease rent + a whole bunch of other fees; my favourite of which is a per-viewing fee which so clearly sets up a wrong incentive. In Canada, most landlords do viewings themselves, and then copy+paste a nice little rental agreement that they probably found on Google.

It is one of the things that makes me proud to be Canadian – that our landlords are so sophisticated that they can rent out their own properties all by themselves.

Just Sign It, Don’t Worry!

The first step in my UK letting process was to sign what was basically a 7-page term sheet/application form. I brought up several issues with the term sheet – some of which didn’t make any sense, and some of which I thought were (in my view) too landlord-friendly…but was assured these could just be addressed in the full tenant agreement.

Then I received the first draft of the full 17-page tenant agreement. I spent about 1.5 hours going through it, and created a Word Doc with about 1.5 pages of – again – things that didn’t make sense or were unfairly landlord-friendly.

Some of my notes were:

• Tenants could not do anything “immoral” on the property
  • I was really hoping the landlord was a heathen
     
• If I died on the property, I (or I guess it would be my estate) would have to reimburse the landlord for losses or damages to the property
  • I guess it wouldn't be worth haunting the house after death
     
• I had to sweep the fireplace/chimney at the end of the lease term
  • …except there was no fireplace in the flat
     
• If I was in breach of the agreement, I would have to pay for the landlord’s parking costs related to rectifying the breach
  • OK, I get that I would be liable for reasonable costs, but I thought it was odd they would specifically include parking costs in the wording
     
• A fee that was payable by the landlord in the term sheet was now payable by the tenant in the draft lease agreement
  • This issue was subsequently settled
     
• No mention of whose responsibility it was to maintain the garden
  • The leasing agent advised multiple times that it would be the landlord’s responsibility

I was basically told that nothing was negotiable.  Even things that didn’t make sense like the fireplace/chimney.

Anyway, I only had a few days left on my temporary AirBnB home so I was starting to panic. I’m all for new experiences and all, but I didn’t want to be homeless 2 weeks after moving to London. So, I held my nose and signed.

You Should Not Have to Shoot Yourself In the Foot To Know It Hurts

A few days after moving in, I spoke directly with the landlord, who (i) purchased a lawnmower that would be stored at the flat, (ii) arranged for a gardener to complete only the initial weeding/gardening, and (iii) told me that weeding/gardening thereafter be only the tenant's responsibility.

I told the landlord that his leasing agent advised that the garden would not be our responsibility, and he responded that he made it clear to his agent that the garden upkeep was the tenant’s responsibility. Since the gardening responsibility was not explicitly covered in the lease agreement, I figured the disagreement was not so much between the landlord and me, but his agent (who made the misrepresentation) and me.

After a few weeks of back-and-forth, the leasing agent got his “director” involved, and then put forth an argument that this supposed disagreement has already been resolved because the landlord purchased a lawnmower that I can use. The director called this a compromise.

After reading the email, I felt like this:

actually, no wait, it was more like this:

I replied generally stating (i) the timeline and facts, including the fact that the agent has admitted to making the misrepresentation, (ii) the damages are quantifiable as one year of gardener costs, and (iii) I failed to see any “compromise” since the landlord did not purchase the lawnmower as a “gift” to me and that I am still entirely responsible for the garden when I should not be in any way.

To be perfectly honest, the cost of hiring a gardener for a year is really not material, and neither is the time to maintain the garden ourselves. However, what I do not like is when people make blatant misrepresentations (intentional or otherwise) and try to weasel their way out of it. I understand people make mistakes. If the letting agent simply said, “Oops, we apologize, we kinda screwed up there…would you be OK if you maintain the garden?” I’d probably say yes, given it is a pretty small sum.

Given they are being weaselly about this situation, my strategy is to take a very aggressive stance and hope that they reimburse me a small portion of that 10-14% in fees they made to just make me go away. The fun part about this situation is that I don’t get the sense the letting agent knows it is a very small sum – probably about £15 every 6-8 weeks. Stay tuned!

Thomas Russo - (Semper Vic Partners L.P.) – His investing approach and three lessons learned from Warren Buffett in 1982

These are our notes from an interesting talk by Thomas Russo at the Ben Graham Centre’s 2017 Value Investing Conference. Semper Vic has generated a compound annual return of 14.6% from 1984 through Q1 2017 compared to 11.0% for the S&P 500. He is a concentrated value investor that focuses on consumer brands.

The full talk can be found here - https://www.youtube.com/watch?v=pFEgm3s1cmc

We also encourage you to take a look at all of their videos - https://www.ivey.uwo.ca/bengrahaminvesting/resources/videos/

 Key takeaways (while not a transcript, his wording has been used as much as possible to convey his thoughts as he presented):

Three Lessons from Warren Buffet

1) The government has given you the gift of deferring taxes on gains. You have to buy and hold to take advantage of this.

2) You can't make a good deal with a bad person. This has entirely to do with agency costs. Berkshire Hathaway has migrated from purely public companies to business that are family controlled and the benefit of a long-term frame of reference. The opportunity costs of management to take from you the owner in a public company is very high and hard to align interests. The families can have dynastic views and long-term thinking and if you can find the right family you can partner with them and have the same alignment (over 60% of their investments are family businesses).

The benefit is family control often comes at a discount as most investors think (wrongly) that professionals managers are really professional and they worry about the family bickering and dynamics, leading to improper allocation of valuation. The mother of all examples is Berkshire.

3)  The ability to do nothing is massively undervalued. Berkshire may do nothing for years and build cash. We're typically fully funded but our portfolio turnover is something like 2.5%. 

Investing business is simple – you are giving up something today if you want more later. Warren says it’s as simple as that and as tough as that. You only know what you actually have right now. You want to increase the odds that you will give up something today and have more later.  So you want businesses that have the ability to reinvest profits.

 The area I have focused on is global consumer brands. Consumers believe that there is not a good substitute (inelastic demand) and pricing power.

 Previous business: Weetabix. Previously owned 20% of the company. Great solid customer base but could not reinvest. Had a pile of cash and purchased at a discount to intrinsic value (8x EBITDA). The family was smart enough to know they could not reinvest and built cash. The Company was ultimately sold to a Chinese group.

 Russo Factors - #1 Capacity to Reinvest

 Capacity to reinvest is defined as global brands with international headquarters usually in Europe. I have focused on international firms headquartered in Europe, which is good as most hate the European focus due to the bleak outlook for European consumer market. We want a less risky way to reinvest profits into the parts of the world that will grow. E.g. Unilever - don’t buy because of great business in England but because it has 85% market share in Vietnam and growing at 12% a year and can pour capital into a high return environment. Heineken - don’t buy because Dutch but because they have the largest presence in Vietnam and the 2nd most profitable market (and didn’t exist in 1994). The Company took high profits in Europe and reinvested elsewhere.

 We also like to buy and invest in family-controlled, which provides us with a double discount. The families do not worry about short-term profits like Wall Street but can focus on long-term multi-generation wealth creation.

 For companies, we look for multicultural and multilingual management teams (example: Nestle). These are soft tissue items but affect if a company has the ability to navigate around the world.

 #2 Capacity to Suffer

 We look for not just capacity to reinvest, but management team must also have capacity to suffer badly. Long-term investments will burden near term profits.

 Example: Berkshire Hathaway – This is the motherlode for capacity to reinvest. Warren Buffett completely disregards reported profits, allowing him to make long-term investment decisions.

 Example: Philip Morris – They have had a miserable four years. They have grown profits by 12% per year for the last four years but the growth has been masked by currency translation as they are based in the U.S. but all of their business is abroad. They did not succumb to wall street’s plea for profits through cutting advertising and other costs. They instead invested in a non-combusted cigarette, delivers 19 milligrams of nicotine in the first minute vs 2 mg of competitors.  They spent $3 billion over three years to develop a platform while none of their competitors spent any meaningful amounts. This hit the bottom line but management was able to suffer through. Product is now doing extremely well with 20% of market share in Japan already. Their competitors reported higher profits through underinvesting but were not building wealth.

New Website Section - Behavioural Finance

We've launched a new section to our website - Behavioural Finance. 

If you ask the average person, they would say that finance and investing is driven by numbers and analysis. Unfortunately, we are all fallible and vulnerable to numerous inherent psychological biases that 1) are documented and repeatable, 2) can completely overwhelm “rational” analysis even when you are aware of the biases, and 3) are compounded by the fact that most people simply do not acknowledge that this happens. When it comes to investing, if these human misjudgements are ignored it will lead to underperformance or even disaster. And even if you are aware you are still vulnerable but at least you have a chance to self-correct.

So here at Canadian Value Investors we are happy to learn from others who have spent the time to understand and document their experiences. Our goal here is to create a list of biases and also relevant case studies that is easy to review and can be used as a checklist/reminder list. We plan to expand this over time. 

Our first person profiled is Charlie Munger, Vice Chairman of Berkshire, with most material being from his 1995 speech at Harvard law. Enjoy! And let us know what you think.

What to do when you don't know what to do

Recently, one of us decided to move from Canada to London, England with no job lined up, while another one just wishes he did the same.

The move has been several months in planning, and I decided that I wanted to take a few months off full-time work and decide what to do next. Before leaving, some people mentioned I am lucky to have this opportunity to take this time off, which at first I agreed with, but then later realized it was an odd statement. If I had instead been laid off or fired (you know, for severance), I would find myself having the same “rare” opportunity! Well, minus the moving part.

First Couple Weeks

In any case, I found a flat relatively quickly, which was great, as my first goal was to avoid homelessness. The only problem is that my building does not have a number…it has a name. Apparently, it is quite common here. Which I guess must make sense in some area of the universe. After all, it is the only house on the street with that name, so it shouldn’t be too difficult to find, right?

Here is a general summary of the first couple weeks:

-          Ordered over 30 different items through Amazon Prime, including a lot of toilet paper, the comfortable desk chair I am currently sitting in, a fire extinguisher (we care about risk management here) and a cat tree (we have a cat)

o   This doesn’t include this last Saturday’s Amazon Fresh order. Did I mention how great it is that groceries can be delivered here? Time is money, or at the very least, time.

-          Started Python programming courses

-          Got frustrated with Python, but have still decided to soldier on......for now

-          Continued reading The Better Angels of Our Nature by Steven Pinker

Job Options

Absent from the list is spending a lot of time thinking about what to do next, but maybe that will come in time. My professional background has been in corporate banking. To those that aren’t familiar, corporate bankers are essentially a company’s relationship banker. For large corporate clients, corporate bankers essentially play the role of a quarterback, in that they are supposed to identify opportunities that the bank can help (read: earn revenues) and bring in relevant teams in for client M&A advice, debt/equity capital markets financing, FX/rates/other hedging, payments and cash management, and other various ancillary products.

Here are the general professions I am/was considering:

-          Private buy-side, either debt or equity:

o   Over the years, I have heard mixed things about PE. Sometimes I hear it is a dream job, and sometimes I hear it is pretty much the same as working in an investment bank. In either case, in my old age (late 20s) I have become – perhaps naïvely so – more concerned about wanting to “add value” and “feel good” about the work I do. To that extent, I am not really interested in (i) PE funds run like M&A shops, and (ii) funds that just lever, cut, and re-lever. It is still on my list, as long as I can find a nice team to work with. However, considering how competitive this space is, I think the bigger problem is finding a team that also wants me.

-           Public buy-side, either debt or equity:

o   I haven’t heard of many public buy-side funds which are run like M&A shops. But you also don’t hear of PE funds that care about the Efficient Frontier. Although in a lot of cases you are just trading pieces of paper, if I can find a good value-oriented fund, I think that would be a lot of fun…d. Though I’d still run into the same problem of wanting-reciprocity.

-          Corporate finance/strategy, within a company (not consulting):

o   This is something that I think could be interesting in a company that truly does allocate capital efficiently. You’d also certainly be closer to understanding a business’ “real” operations, as opposed to viewing it from a distance as you would in banking. One issue is that sometimes these job requirements include having some form of CA/accounting designation. I guess doing bank confirmations at 11PM must translate into intelligent capital allocation.  

-          Insurance underwriting:

o   This could be kind of cool, especially when you’re getting into specialty insurance. I’m not sure how I’d fit in exactly, but to anyone who knows me, I love a good probability-based bet. 

-          Non-profit work:

o   In developing markets, it seems like there are opportunities for low-hanging fruit investments with phenomenally high social returns on capital. I’ve looked at social enterprise funds, and the ideal fund does both social and investment returns well. Understanding the difficulties in doing this, to me, they should at least do one well. It is hard to separate the good from the bad. But I am open minded.

-          Corporate lending/banking or capital markets:

o   Similar to my background, but I figured why not try something new.

-          M&A advisory or sell-side research:

o   Let’s not go there. In all seriousness, I think working for an independent-minded research analyst would be good experience, though. 

-          Other stuff:

o   Given our blog has an enviable subscriber number in the double-digits, I am also open to suggestions!