Is there life beyond the P/E ratio?
In union is strength
Caledonian collaboration
As shares in Lehman Brothers headed towards the floor last summer, many were sure it was on the verge of bankruptcy. Not all, though. The fund managers at Franklin Mutual Series mutual funds could hardly believe their luck. Here was a bank trading at 65% of its book value, yet with what they considered to be a strong franchise in investment banking and fixed income. So they bought the stock.
A classic example of value-investing, and something which Franklin Mutual has been doing for 50 years now. But the last few years have not been so kind to value investors: growth and momentum stocks have been the big movers, especially in the US. Franklin Mutual has suffered along with the rest - with a bit of managerial restructuring along the way, of course. The pressure can be immense: as momentum stocks, such as technology and internet-related businesses, bring in almost instant double-, often triple-digit returns, how do you persuade your clients to keep their money with you?
Franklin Mutual now has $22 billion under management, as opposed to a high of $33 billion, and has stuck to its guns. "If you are a true value investor, over a decade you will have one fantastic year, one weak year, and eight where you'll do just fine," says chief investment officer Rob Friedman. "In other words, don't overreact to the two extraordinary years."
The big story it has to tell is Europe, which accounts for most of the 20% of its assets invested in non-US stocks. The philosophy of the mutual fund is the same as that of its domestic counterparts, in other words: "To invest in those stocks which are unloved, beaten up, out of favour or where new management takes over tired old businesses," says David Marcus, sole portfolio manager of the Mutual European Fund, as well as co-manager for the Mutual Discovery Fund and Mutual Shares Fund.
It requires seeking value in those very corporations that everyone else ignores. Literally, in one case. "I went to an analysts' meeting given by the new chairman at French water company Suez," says David Marcus, "I was the only one there who didn't work for the company. No one else bothered because they all thought it was a dead company."
They weren't far wrong. It was on the brink of bankruptcy, even though it had so many other assets locked up inside the conglomerate. New CEO at the time, Gerard Mestrallet, turned it around by concentrating on its water holdings and spinning off the rest, and merging with another conglomerate, Lyonnaise des Eaux, whose share price had hardly moved in seven years
Marcus met the chairman when he was on a marketing trip to the US. Marcus was pleasantly surprised by what he heard. "He sat opposite me, and told me that he had analyzed the portfolio of assets the company held, and had realized that water was the best business to be in." Marcus was stunned. Here was a company, publicly listed for over 80 years, which had spent the majority of its time in recent memory trying to diversify from its core water assets, which was now talking of reversing the strategy. "I looked at him agog, I was so stunned," says Marcus. "He obviously knew what I was thinking because he said 'yes, I know, we were shocked too'."
That was nearly four years ago, and now he owns 3% of the combined company - about $300 million.
He's picked out other companies, too. CGIP, for example, a family-run holding company which held 25% of Cap Gemini. The most recent managing director, Ernest Seillière, had got his position in part because his wife was a member of the ruling family; yet his first decision was to stop any more family members being appointed; the company was to be run as a business from now on, not a family shop. At the time he took over, the stock was trading at 50% discount to the company's net asset value. "When I started to look at the firm, and to consider investing, other investors and our brokers thought I was mad and was wasting time as well as money," explains Marcus. "But I had met him, and heard him bemoan the fact that no matter what he did, his company was always undervalued, and that he was going to devise ways to change that. I loved his enthusiasm and commitment, and bought a stake." Another investment for Marcus which paid off.
But it is the Suez Lyonnaise des Eaux connection which has benefited Marcus most. On the one hand, he says, "such companies remember you if you follow them and believe in them when they're down". When the managers of the merged company come to New York, he's first on their list to call.
More significantly for future business, it got Marcus a meeting with Albert Frère in the spring of this year. Frère is the richest man in Belgium, having made his fortune from a steel company his father owned. At 73, Frère owns a conglomerate which has stakes in a multitude of businesses, including controlling interests in, among others, Autofina, Electrofina and Petrofina.
He never meets analysts, but Marcus tried his luck. He was about to sell the fund's stake in Electrofina, with the deal all but signed, when he instructed his brokers to tell the other side that it was a deal only if Frère agreed to meet him.
Much to Marcus's surprise, Frère agreed. Their first words set the scene for a fruitful discussion. Recalls Marcus: "He said to me that he held a 12% stake in Suez, and so was the largest stockholder. So why should he talk to me, since I had just 3%? I said 'fair enough', but told him that I had bought my stake six months before he did." That seemed to impress Frère, and the two spent the rest of the meeting discussing European stocks.