Richard Pzena: Doubling Down in Financials

When it comes to value investing or buying out-of-favor stocks, patience is a virtue. These days few are more virtuous than Richard Pzena, Chairman of Pzena Investment Management, a $20 billion assets money management company whose New York Stock Exchange listed shares are down more than 38% in the last 12 months.

Pzena, 49, is a contrarian value investor, and, in the third quarter of 2007, he decided that beaten-up banks would provide the best bang for his investors' buck. He bet big on stocks like Citigroup, thinking that the bottom was near and they were ripe for turnarounds. Needless to say, Pzena was early.

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Investors fear a massive unwinding of debt will undermine the world’s economies. But the data indicates deleveraging doesn’t equal disaster.

A new fear has permeated conventional investment thinking: the massive leveraging-up of the recent past has gone too far and its unwinding will permanently hobble the global financial system. This view sees Bear Stearns as just one casualty in a gathering wave that has already claimed many U.S. subprime mortgage originators along with several non-U.S. financial institutions and will cause countless others to fail. And it sees the earnings power of those that survive as being permanently impaired.

The obvious question then is, which scenario is more logical: the extreme outlook described above, given the long period of easy credit extended to unqualified individuals? Or the scenario of a typical credit cycle that will work its way out as other post- excess crises have, and without impairing the long-term ROEs of the survivors? We believe the latter. Here’s why:

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Richard Pzena: Opportunity Amid the Ruins

What is the upside for their shares?

Fannie and Freddie are selling for 25% or 35% of what they are worth. The upside is three- or four-fold once the mortgage crisis unfolds. These stocks in the $20s don't make any sense, even in a bear case where they have to raise lots of capital. Even if Freddie has to issue $5 billion in equity at $20 a share, massively diluting the existing shareholder base, you still come up with earnings power of almost $4 a share. In a best-case situation, assuming nobody else gets back into this market and they are the only game in town, you can get $9-$10 of earnings power for a stock that is in the $20s. You don't ever see that kind of risk/reward trade-off. Hence, big positions for us in both Fannie and Freddie.

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Pzena Investment Management's IPO presentation

Good presentation regarding how Pzena Investment Management built its AUM from $3billion to $30billion.

Important take home messages:

1. To be a successful investment firm, one has to deliver long-term superior results through constant, repeatable process that clients could understand.
2. The first step towards finding potential investments is using its own proprietary screening method. For every industry, Pzena's team would rank all the companies into five quintiles. The way they do it is by using its current earning and extrapolate naively into the next few years what its earning should be. Then, they would concentrate on finding potential investments on the top quintile.
3. Three most important questions they ask themselves regarding potential investments are:
   a) Is this company any good? b) Are the problems temporary? c) Will its earning rebound back to normal?
4. Pzena and his teams will only invest in companies that answer "Yes" to all those questions.
5. Thought process: Think like a business owner rather than a stock picker.
6. Pzena team thinks like a business owner and imagine that they are like private equity, buying the whole business and thinking what the companies will earn in future.
   
7. One example that Richard Pzena used was Boeing. Post 9/11, Boeing stock took a hit, dropped from the $70s to the $20s. Through Pzena's own proprietary stock screen, it showed up on the top quintile.
8. The conclusion that they made on Boeing was it is a superior company with only one competitor, it has very sticky customers as they would use the same company to service their planes to keep their costs down, it has defense business that is doing well and thus provides downside protection and they believed that its business should rebound in a few years.
9. Boeing is definitely a wonderful business, clouded by temporary problems and will have higher normalised earnings in future.
10. Investment decision: A team approach.
11. For every portfolio, there are 3 co-portfolio managers and everyone of them would have to unanimously say "Yes" before a stock is added into the portfolio.
12. Buying an selling strategy: Rigid and discipline; Pay no attention to portfolio managers' intuition.
13. They would only buy companies ("Yes to all 3 important questions") that are ranked on the top quintile and sell when the prices approach the middle quintile. Period.
14. Portfolio diversification: Concentrated portfolio with 25 to 30 stocks.
15. Clients education: Pzena team spends good amount of time educating clients what they are doing and discourage clients who might be upset or nervous if the funds are not doing well in the next 1, 2, 3 or 4 quarters.
    
16. This will results in highly educated and sticky clients.
17. In summary: Pzena team uses old fashion, holy grail approach of investing: Buying good businesses, which are available at low prices caused by temporary problems with high likelihood that earnings will rebound in future.
    

To watch this excellent presentation, please visit: Retail Road Show

Richard Pzena: Lear Undervaluation Summary

1. Lear’s core business of automotive seating is fundamentally sound and has good long term prospects. While Lear’s earnings came under pressure in recent years, there are signs that the business is recovering and delivering strong results. Lear has reported two positive earnings surprises in the last three months.
2. The Icahn offer of $36 is inadequate and significantly undervalues the company. We believe that Lear’s core auto business of seating, electrical and electronics is worth over $50. Its share of the interiors joint-venture with Wilbur Ross is worth over $4. Lear’s sizable tax loss carry-forward is worth $4 as well. Hence we estimate that Lear is worth $55-$60.
3. The flawed process of the deal put Carl Icahn in a highly privileged position and made it unlikely that competing offers would surface. The ‘poison put’ that Lear inserted into its November 2006 debt offering and large break-up fee payable to Icahn if another bidder was selected made it much more difficult and costly for other potential bidders. Further, management is conflicted given their significantly enhanced economic interest in the company following the deal. Thus, the lack of a competing offer in no way implies that the buyout offer is fair.
4. There is no compelling reason to sell the company at the present time when business recovery is just under way. There are challenges and risks involved in executing Lear’s long term business plan, as there are in any business. The strategy of pursuing non-Big-3 customers is working as evidenced by the growing Asian business at Lear. The recent settlement between Delphi and the union is one major step in the direction of lower probability of short term production disruption in North America and longer term restructuring of the Big-3’s North American operations.
5. Since the Icahn offer in February, the auto suppliers sector has rallied on average by 15%. Lear’s share price has been capped by the offer while earnings guidance has increased by 7%. Should shareholders reject the deal, we do not think that the near term downside risk to Lear’s current price is significant in light of the current valuation of the sector.

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Source: Lincoln Minor

IPO for Pzena Investment Management

Joel Greenblatt said that Richard Pzena is the smartest guy he has known!

Founded in late 1995, Pzena Investment Management, LLC is a premier value-oriented investment management firm with a record of investment excellence and exceptional client service. We have established a positive, team-oriented culture that enables us to attract and retain the best people. Over the past eleven years, we have built a diverse, global client base of respected and sophisticated investors. As of March 31, 2007, we managed approximately $28.5 billion across a range of value investing strategies on behalf of institutions, high net worth individuals, and select third-party distributed mutual funds.

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Source: Lincoln Minor

Richard Pzena: Lear Corporation Presentation

We are writing to express our alarm about the possible sale of Lear Corporation to Carl Icahn’s American Real Estate Partners LP at a price which we believe to be far below the fair value of the company. As you know, we are one of Lear’s largest shareholders and we have long believed in Lear’s business and its plan for recovery. Our view is that the company’s earnings are well below their normal level and that Lear is being valued by the market as if there is little chance of an earnings recovery. Our analysis suggests that earnings are likely to recover to more than $4.00 per share over the next few years from consensus analyst estimates of $2.00 per share for 2007. Consequently, we believe the company’s value to be closer to $60 per share.

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Source: Lincoln Minor