Ponzio's notes on Monish Pabrai's presentation

Notes from the Pabrai Funds 2008 Annual Meeting

by Joe Ponzio

On September 13th, I attended the 2008 Pabrai Funds annual meeting held here in Chicago. I met a few F Wall Street visitors and, unfortunately, missed meeting up with a few others. I must say that I am amazed at how many "Early Buffett" partnerships are out there.

For the explosive growth of these types of partnerships, I give 100% of the credit to Mohnish Pabrai for structuring his partnerships like the early Buffett ones and bringing them to the public eye. (If that's Greek to you, or if you're Greek and that's Chinese, stay tuned because I'll explain "Early Buffett Partnerships" in a subsequent post.) Before Pabrai, few people knew what an "Early Buffett" partnership was.

But I digress (and I'll get back to these partnerships later). For now, let's look at the Pabrai Funds 2008 annual meeting.

A Look at Performance

Pabrai's funds are all about long-term performance; so, looking at his one-year or year-to-date performance is downright silly. Sure, he'd love to show positive gains every year; still, even Charlie Munger himself couldn't pull off that feat, and Munger's not too shabby of an investor!

You didn't know? Like Buffett, Munger ran a partnership in the 1960s and 1970s. And like Buffett, he killed the Dow — except in 1973 and 1974, when Munger's partners lost about 53% over those two years. By comparison, Pabrai is doing quite well.

(How did Uncle Charlie's story end? In 1975, Munger's partnership earned a 73% return. When Munger liquidated the partnership, he had compounded money at just over 24% for fourteen years, even through the 53% two year decline.)

Pabrai's Presentation

Mohnish Pabrai talked for about 30 minutes or so (could have been longer...I wasn't watching the clock) and then opened the floor up for questions. (He won't discuss current or prospective holdings; so, I couldn't ask some of your questions.)

Pinnacle Airlines. Mohnish admitted that he would have been better off spending $20 on a book than $20 million (or whatever the real loss was) on Pinnacle. Airlines are tough, and Pabrai admitted that he should have learned from Buffett's lesson (or "beating") on US Air.

The takeaway lesson on Pinnacle. Airlines are typically bad businesses to invest in. Like auto makers, airlines have thin profit margins, suffer from high capital expenditures, and have to compete on price. Most investors should stay away from airlines entirely.

Investing in China. I'll give you the "short short version" of Pabrai on investing in China:

It is said that they maintain three books: one for running the business, one for the government...and one for the owner's wife.

Pabrai does not plan on making any investments in Chinese companies (though I don't think he'd rule the right opportunity out just because it's in China). Instead, he continues to believe that there are plenty of opportunities in the US.

Delta Financial (and other financials). Pabrai said that the big mistake he made on this one was not figuring out the "lifeline" for Delta. That is, he didn't properly assess the outs for the company and his investment. He then had this to say about Delta and the financial crisis (as well as all debt):

If you depend on borrowed money, you have to worry about what world thinks of you everyday.

(This was actually a quote ripped from Buffett at the Berkshire annual meeting on May 3, 2008. I give an example of this "borrowed money" danger in this post.)

Think about it personally — until your house is paid off, you have to worry about what the banks think of you. If you carry credit card debt, you have to worry that your interest rate will shoot up because the credit card company's opinion of you and your "creditworthiness" has changed.

Back to Delta: Mohnish said very simply that he did not consider the fact that the credit/securitization markets would completely freeze up. In short, he was "unprepared for a 1 in 50 year event."

Berkshire Hathaway. Over the years, Pabrai has been using Berkshire as a "placeholder" of sorts for up to 10% of his portfolio's cash. He'll hold it for a few days to a few months, and figures that he's averaged about 12% a year on it. (Beats the heck out of cash!)

He also talked about Buffett and Munger's amazing ability to compound money, "adding a zero every ten years." That is to say, every ten years or so, they added another zero to Berkshire's price ($40 to $400 to $4,000 to $40,000).

A Change in Strategy

Pabrai did talk about making a change in his strategy over the past year or so. He is now focusing more on the jockey (management) than the horse (cold financials). I took it this way: Up until a year ago, Pabrai was more than happy to "cigar butt" invest — find underpriced assets regardless of their quality.

Today, he is shifting to a more 1980s Buffett-style approach — find strong businesses run by highly talented, shareholder-focused managers.

Pabrai's Current Portfolio

Looking at his portfolio, Pabrai sees the widest discount to intrinsic value today than at any other point in the history of his partnerships. Some positions are trading at just 25% of his estimation of intrinsic value.

What will cause convergence of price and value? Pabrai talked about two types of assets in the portfolio:

• hard assets and book value;
  
• future earnings streams and cash flows.

Hard Assets — the Frontline Example

When Pabrai purchased frontline, the market value was less than one half of the liquidation value — a situation that cannot persist forever. Eventually, that price must correct because:

• Wall Street will recognize its mistake in improperly pricing the business; or,
  
• Someone will also recognize that value and begin buying, pushing the price upwards.

If the business is generated positive cash flow every month, that gap between price and intrinsic value widens every month. The widening of that gap puts tremendous pressure for the price to move up.

As Mohnish put it, "It's Ben Graham 101." Eventually market value (price) and intrinsic value will converge.

Future Earnings Stream as a Value Driver

In this case, Mohnish used IPSCO as an example. He bought the company at less than three times free cash flow. Thus, if the price did not change in three years, the market cap would be less than the cash on the books of the business.

What does that mean?

Plants, Inventory, Future Earnings Streams, Growth, Management, Permits, Licenses, Talented Employees — all free!

That "obvious" value caused tremendous pressure for upward movement in price. Pabrai bought for $45 and sold for over $155.

(As an aside, Pabrai said many of his holdings are trading at low single-digit multiples of free cash flow.)

The Pabrai Meeting Summary

All in all, it was a wonderful meeting and evening. You might think that Pabrai would be sheepish or cautious considering his recent performance; but, seeing the man in person, you can easily see that he believes his recent performance is not a problem in strategy (a strategy with a long, successful history with many mangers throughout history) but a problem with market prices and action.

Regrettably, I missed the Warren roundtable. At the end of the evening, Mohnish sat at a table with ten or twelve other attendees (whoever wanted to) and discussed his experiences at lunch with Buffett. But, I'll end with some points Mohnish had thrown out about Buffett earlier in the evening:

1. Buffett is a very reasonable person — full of energy and passion. As Mohnish put it, he's the type of person that comes along once in a century, like Einstein or Ben Franklin.
2. Warren Buffett posited: In investing, you have to make tough choices. As a non-investment example...would you want to be the best lover in the world, but have the world think you're the worst? Or, would you rather be the worst lover in the world, but have the world think you're the best?
3. Finally, do what you love.

And I'll add some wisdom to that last one — wisdom that Buffett surely implied and that my father always told me:

To be the best at what you do, you have to do what you love. And if you're the best, the money will follow. And that's true whether you're saving lives or digging ditches.