Thursday, July 25, 2013

Boyles Asset Management - Q2 2013 Letter Excerpt

Below are a couple of sections (slightly edited for public viewing) from a letter just sent to the investors of the fund I help manage.

Disclosure: I am a portfolio manager at Boyles Asset Management, LLC ("Boyles") and the fund managed by Boyles owns shares of stock in a company or companies mentioned in the excerpt below.  We may in the future buy or sell shares in the fund and are under no obligation to update our activities. This is for information purposes only and is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.


July 25, 2013

When one discovers a bargain asset whose owner might find it unimportant or inconsequential, the potential exists for a highly profitable transaction.

It Matters to Me

Classic economic thinking might suggest otherwise, but there are times when a seller of a financial asset cares little about what price he or she receives.  Perhaps there is a need for immediate liquidity at any price or perhaps the goal of the seller is social rather than economic.  We suspect there are other reasons (which we hope to take advantage of in due course), but we would like to highlight one relevant additional example from our first two months of operation.

In the prior fund we managed, we owned a small UK software company named Electronic Data Processing (LSE: EDP).  The company is small and its stock relatively illiquid.  With our increased capital base at Boyles, we were unsure if we’d be able to meaningfully participate in a company that we believed was materially mispriced in the marketplace.  When we began operations at Boyles, one of your intrepid managing partners began cold-calling some of EDP’s large stockholders, which were primarily listed trusts in the UK that operate like closed-end funds.  One such owner of a large block was an entity with nearly £525 million in equity.  When it was clear that the chief investment officer of that organization knew very little about the current circumstances surrounding its £1.11 million position in EDP—representing a mere 0.21% of the organization’s equity—the conversation shifted to one about Boyles acquiring the firm’s stake.  It was agreed that two days later Boyles would have a bid prepared.

During this period the stock had traded as high as 64p per share and was generally in a range of 60p to 64p.  The potential seller recommended to us that the deal be done at the mid-point of the bid/ask at the time or perhaps even higher than the ask, given the large nature of the block.  After we indicated our bid was 55p we received a verbal accosting about our unreasonableness, our poor conduct, and our general approach to dealmaking.  After we reiterated that it was our best and final offer, the conversation came to an abrupt close.  The story naturally didn’t finish there, as just 24 hours later the firm came back to us “with their tail between their legs” and asked if the offer was still on the table.  We closed the block transaction at 55p later that week.

The moral of the story, of course, is to acquire assets from folks that ultimately care very little if they get “X” or “0.8X” because it won’t ultimately affect their net worth and the position may just be a nuisance for them to own.  Buy small operating units or assets of large organizations; or small holdings of large investment firms.

Shortly after our transaction, the company announced updated results and declared a special 5p dividend.

Discipline and Patience

“If we are to hit the bull’s-eye, we will need markets that allow the purchase of businesses and securities on sensible terms. Right now, markets are difficult, but they can - and will - change in unexpected ways and at unexpected times.  In the meantime, we’ll try to resist the temptation to do something marginal simply because we are long on cash.  There’s no use running if you’re on the wrong road.” -Warren Buffett, 1993 Letter to Shareholders

Do-something syndrome is a disease that infects many investors, both professional and amateur.  Professional investors feel they need to do something to earn their fees; and both professionals and non-professionals alike feel the urge to “get in on the action.”

The human psyche is made to fall for stories and when added to the do-something syndrome the resulting combination can be a potent detriment to one’s investment objective.  The mind likes a good narrative, and it is easy to fall into the trap of mistaking a good narrative for a good investment, perhaps especially when you feel you need to do something.  Whether it’s internet stocks, residential real estate, tulip bulbs, or something less euphoric, a good story can compel people to do something—anything—and break away from their discipline (if they had one to begin with).

If we are to be successful over a long period of time, we must be disciplined in waiting for the combination of the right businesses and right prices before putting capital to work.  At times, this philosophy may dictate more investing and less waiting; and at other times, there may be a lot of waiting with very little investing.

Our goals are capital preservation and long-term (five years or more) outperformance, not just to invest for the sake of investing or to satisfy an urge to do something.  But we remind partners and readers that there is plenty of activity going on behind the scenes: looking for businesses we’d like to own and thinking about the prices at which we’d like to buy shares in those businesses, improving our process, developing specific industry knowledge and growing our network of industry contacts.  Much is happening even if we are doing more waiting.

Just as we need to be disciplined in our waiting, we also need to be ready to act decisively when the opportunity to take the bat off the shoulder and swing at a fat pitch presents itself.  To use another Buffett quote: “In the search, we adopt the same attitude one might find appropriate in looking for a spouse:  It pays to be active, interested and open-minded, but it does not pay to be in a hurry.”