Interview and Q&A with Andrew Brown, portfolio manager and founder of the East 72 holdings fund and of the East 72 Dynastry trust fund.
You can follow Andrew on Twitter through two handles: @abroninvestor (a wider range of tweets) and @east72holdings (strictly investment). I strongly suggest everyone to hava a look at all his writeups which you can find on his website: east 72 website
Hello Andrew! Here are the questions! I will only publish it when you give me the go and that everything is ok for you.
First of all many thanks Andrew for accepting this interview! Let's get right into the interview!
Can you tell us how you became interested in investing
Simple! I won the stock picking competition in my economics class at school when we did the part of the course which dealt with the role of stock exchanges and money markets in the UK economy (I grew up in Northern England). I remember the stock distinctly – Thomson Organisation – the UK arm of the Thomson family from Canada with interests in newspapers (notably the Times), travel (holidays and airplanes) and book publishing. After Roy Thomson’s death in 1976, the company reorganised and brought in the family’s privately owned North Sea oil interests.
There’s a fair precursor, at a much younger age to what fascinated me then and still does now: conglomerates controlled by a family magnate. What’s more glamourous in the late 1970’s than airplanes, oil wells and newspapers? Of course the company is still around focused on data provision as Thomson Reuters.
Can you present yourself and your fund?
I have 40+ years investing experience on the sell side as an analyst with Baring Securities and County NatWest (now Citigroup in Australia) predominantly in financials – banks and insurers – and as an analyst, portfolio manager (AMP) and Head of Equities (Rothschild). For the last 20 years I’ve worked for myself and have been a director of 14 public companies ranging from minerals exploration (the stock six-bagged in a few weeks but I couldn’t sell any) to financial planning (the stock six-bagged over ten years). So I know what a good (and bad) boardroom looks like.
East 72 Dynasty Trust is my first open ended investment company – I have run some closed end ones, in which we have used gearing and derivatives which could have done better, and so we’ve moved to a simple straightforward unhedged, ungeared structure. Dynasty Trust is still small since it was only established around the start of 2023.
What is the meaning behind East72 the name of your fund ?
I have worked in London and New York before emigrating to Australia. In New York, where I worked for a small Australian stockbroker, I used to live on East 72nd Street between Second and Third Avenue. I learned so much being in the Big Apple so I thought I would use that name.
How did you become interested in the Bolloré galaxy? Why do you think it is a good investment?
Really got to know about it when they raided Rue Imperiale de Lyon to put the squeeze on Michel David-Weill at Lazard which I thought was an amazing strategy – being located in Australia I have always had an interest in “entrepreneurial raiders” but started to realise Vincent Bollore was a cut above many others in the field. The ability to build from the ground up and his interest in “media” in the widest sense was an added interest.
I love the fact that Bollore are realising some very long held assets for excellent prices so will have a massive cash bank at a time asset prices are most likely to fall. Clearly I figure media will be a real focus and that’s tough to analyse because of the very diverse cash flow/earnings multiples. It’s a good investment because you are buying to line up alongside one of the smartest investors of the past 50years at half its real value without even adjusting for cash. Where else can you say that? The top companies in the group have share prices which are absurdly low.
What attracts you to family holdings as your East 72 Dynasty Fund is dedicated to them ?
There are three elements I’ve touched on in the first few questions that come together in family controlled companies.
Many of them are conglomerates so that you have to be a good generalist. Larger active managers tend to focus on industries and they don’t always make sense for a big specialist funds manager to focus on – their complexity demands a lot of effort, are sometimes thinly traded and can be controversial. Hence, there is usually little analysis of them by brokers. Analysis of them is virtually exclusively on the buy side, who often don’t want to give all their secrets away. So there are real chances of mispricing; it’s not just backing the family – you need to identify a margin of safety to say “I’m backing the family at a 60% discount to intrinsic value”
Rothschild. You work for the family and it’s not a “brand name”. It’s a centuries-old family heritage over the door, which is fiercely protected. So for many of the patriarchs within the family, it’s not about excitement but preservation of wealth and reputation. Now, of course, you don’t want the family to be too staid, and be left behind. Hence, we try to find that fine balance between reputation, preservation but forward thinking and intellect. Exor, the Agnelli family vehicle run by John Elkann is a fabulous example of that balance – and amazing capital management skills.
Insurance analysis. Insurance really forces you to do “sum of the parts”, not just in Berkshire, Markel or Fairfax Financial, but even a simpler company. The insurer doesn’t need ALL of the capital to run the business and so you can separate out the capital which IS needed to run the insurance operations from that which the regulator forces you to hold and the surplus capital which you can put to work in longer dated assets – equities and private businesses. “Sum of the parts” is my staple valuation tool as you would expect – many of the companies I analyse are “assets” bolted to income streams (eg Vivendi)
Why does France have so many interesting companies?
Observing from a “young” country (Australia has the oldest civilisation on earth but was only colonised in the late 18th century which it i still coming to grips with!) I believe it is a unique mixture of culture, history and politics. For example, the type of state intervention in the economy would not be tolerated in other countries – past bank nationalisation, history of Credit Lyonnais, interests in the high technology sector in such as Airbus – along with a fearsome bureaucracy and “rules”. Relative to Australia which tries to run too quickly and encourages short term behaviour, French public companies don’t rush to release results, with slack timetables, and are forced to divulge massive amounts of usable (and unusable!) information, emerging six months after year end. That means there’s a lack of “spin”. Moreover, the history of the country encourages older style families to be conservative, even hoard and be cognisant that things can change. It’s like the culture of fine wine – don’t rush it and drink it too early. In many ways, the French benefit from this attitude of quality taking time – a new generation of younger monied consumers are discovering quality costs – be it very overpriced burgundy or a Hermes handbag.
The mix of patience, technology and a culture that doesn’t question centrist/left politics mixed with hidden or understated wealth (“bo-bo”) makes it confusing for mainstream investors and hedge funds who often fail to recognise it is accompanied by a strong legal system. It’s a perfect environment for someone like me.
What is your current best idea?
My current best idea is not family controlled but is 42% controlled by its founders and management team via ownership of a different class of shares. It has had to endure a difficult past twelve months with regulatory threats where it is publicly aggressive towards its regulator – Gary Gensler – Chair of US Securities and Exchange Commission – who has turned the tables on this company by slapping it with a “Wells Notice” (notice of potential enforcement action) in June 2023. The core “commodity” price which it “mines” has been reasonably depressed over recent months – particularly so in two of the past four quarters. This company is the second largest liquidity provider in the US – Virtu Financial (VIRT) – behind the giant privately owned Citadel.
Virtu has 96million publicly traded shares and 69million non traded mainly held by Virtu Financial LLC; in combination the 165million shares at the public price of $18.95 give the company an equity market value of US$3.1billion; it also has $1.8billion of long term debt costing $91million in interest.
The company provides services to clients by market making within various asset classes, but still predominantly equities. In the USA given the proliferation of exchanges Virtu uses its technology to offer executions within the “national best-bid offer” spread to clients such as Interactive Brokers. It also operates an execution services business (the old ITG) whereby it can take over the dealing function of a small to medium size funds manager.
Virtu benefits from three things:
Its core commodity price – realised volatility. Clearly higher volatility means larger spreads and higher margins. Whilst VIX is a decent proxy, it is not fully realistic since at times actual realized volatility has been as low as 55% as VIX implied volatility (usually around 80%);
Volumes traded – especially by “retail” - so called Rule 605 clients meaning that IBKR metrics are a reasonable expression of the opportunity set for VIRT;
The combination of the two.
Virtu is no smooth quarterly operator; its core “top-line” measure of profit is “ANTI/day” – adjusted net trading income of margin less dividends and interest paid away and exchange/data fees. In Q1 CY2020, when COVID send world markets spiralling, Virtu averaged ANTI of $12.7million a day over the quarter and in a brief period was earning three times this. Realized S&P volatility was 57% over the quarter. In Q1 2021, realized volatility was only 16% but average US daily volume was 14.6million shares versus 11m in the “COVID crash” – Virtu earned $11.7mn a day in this period when the meme stocks went beserk.
The company’s core profit measure it displays is “Adjusted EBITDA” – basically ANTI less overhead and long term funding costs. Naturally we make adjustments to that by adding back the removed stock based compensation but also fully expense the “acquired” (i.e. company created) software expense to fully expense that and then fully tax the resultant bottom line. This is a massively technology driven business with cash spend of >$25million a quarter. We get a smaller number than the company promotes as “adjusted EPS”.
In the latest Q2 2023, realized volatility was below 12%, volumes were modest and ANTI/day is ~$4.5million. Virtu is a good counter-market investment tending to do well if equities dislocate. At $18.95, the shares trade at 2.9x our PEAK adjusted net earnings (adding back capitalised expenses) of $6.53/share ($1.12billion) in 2020, 4.2x 2021 earnings of $4.53/share, and 11.1x LTM depressed adjusted earnings of $1.66.
Virtu has bought back 15% of the shares (gross) on issue at 30 September 2020 in the past 30months at a cost of ~$1billion (~$25.25/share) and maintained a $0.24 quarterly dividend, so the shares offer a 5% yield whilst you wait for market conditions to “deteriorate”. On occasion, the capital management has been a little too aggressive but the intent (see below!) can’t be faulted. Virtu is one of our larger positions in Dynasty Trust.
Is capital allocation decisive for you when you evaluate management? Why?
Oh Yes! Coming from Australia,we hveso many companies who do not manage capital well. They buy shares back when they want to prop up the company’s share price, rather than when the shares are undervalued on the market. I have had screaming matches with directors who buy back shares but can’t tell me what the value the company at!
I am currently arguing with a microcap company which operates in a cyclically depressed sector and whose shares trade below half asset backing. They want to husband their cash because they think times are tough. But they don’t look at the other side of the argument which is that is why their shares are so cheep and that they can buy back 10% of the company 50%+ below NAV using less than half their cash pile.
Our favourite asset allocator is Exor – the track record at adding value through spin-offs, asset sales, buybacks and delicate use of appropriately structured debt is hard to beat. Why more business folks don’t look more deeply at Exor stuns me. When I hear “macho” Australian directors saying that share buybacks are an admission of defeat, I make a note. Don’t invest in their company ever. Growth for growth’s sake, the antithesis of most family controlled businesses.
When do you decide to sell a holding?
If you read the mistakes section later, probably just before it is about to triple-bag.....
More seriously, each of my positions has a thesis and a valuation behind it. So if the thesis is breaking down due to industry, management, competition or other factors, then I would look to exit. I will look to reduce my holding if the valuation is being exceeded by the share price and I don’t see additional value add. Some of our theses are quite vague but as long as we are getting paid by dividends or closures of shares to NAV we are happy to hold. We also look for misunderstood growth opportunities, which we will divest if they get to become market favourites.
What are the most important elements of your checklist?
Valuation and capacity to maintain the business in respect of cash flow. With the changes in accounting standards over the past few years – especially that appalling IAS16 – I really look to rework the cash flow statement to make the accounts look like a normal business not having “rent” as a “financing cash flow”. Hence my checklists focus on companies that “cheat” and try and push figures on you with truckloads of capitalised software – which they write off as an abnormal every five years, and try to pretend rent doesn’t exist. Numeric fakery is a part of my checklist.
Of course, that leads directly into the valuation process to assess what are realistic maintainable earnings and cash flow. It also means that screening is NOT a part of my assessment process; think “how do you screen for Bollore?”. Reading is a much bigger part
It does mean that I will invest in industries with a moderate outlook so long as they are cheap enough to ensure I will at least get my money back in a liquidation.
What are your red flags?
Since at heart I’m a value investor, then pushing the accounting to its limits and promoting permissive “profit” and “asset” figures are a clear problem for me. I do focus quite a bit on restating company accounts the way I would like to see then presented to get to “core” profits and values. Excessive company promotion focusing on “tactics” presented in detail as “strategy” (or something the IR team clearly dreamed up the week before) is a big flag. Just get your software to search the words “capitalised” and “deferred” in relevant publications...
What was your biggest mistake and what did you learn from it?
There are three types of investing mistakes in my view: buying a dud, selling too early and not taking advantage of investments in your area of expertise.
My mistakes of buying poor securities have not been that bad (there are enough, obviously). I am feeling very embarrassed at present because I did a lot of valuation work on Fairfax Financial about three years ago, real deconsolidation to strip it back. I got frustrated because the company used to do major deals just after period end. So I parked the work. Big mistake! The stock has trebled over the past three years as the reinsurance market has hardened and management have been aggressive buyers of their own stock. And I missed it.
My really worst mistakes are selling too early. In April 2020 I wrote two articles you can find on the net “For want of a coffee can we left $7million on the table” (in a really small company) and its successor “Coffee Can Number 2: The $25million Sequel”. The articles show a real life example of not holding on to stocks which multi-bagged and we exited early. I strongly believe you have to have clear business reasons to sell. Our major mistake was selling a strongly growing funds management business, in essence, “because it had gone up”. You have to be just as disciplined with sells as buys.
In the meantime, thanks again for signing up and feel free to talk to your friends / fellow investors about the French Hidden Champions Substack. You can also reach out by email or by DM on Twitter @FoxCastlehold.
Disclaimer: The above article constitutes the authors’ personal views and is for entertainment purposes only. It is not to be construed as financial advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. The authors may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article. Disclosure – I (Jeremy) hold a position in the Bolloré Galaxy entities at the time of publishing this article (this is a disclosure and NOT A RECOMMANDATION)