Kingstown Capital Management

Michael Blitzer and Guy Shanon are the Managing Partners of Kingstown Capital, a value-oriented investment partnership that focuses on special situation securities across the capital structure. The firm was founded in 2006 with strategic backing from Gotham Capital and currently manages $1.8B. Michael and Guy both hold MBAs from Columbia Business School where they participated in the Value Investing Program and have taught Applied Value Investing as adjunct faculty. Michael currently serves on the Executive Advisory Board of the Heibrunn Center.

Graham & Doddsville (G&D): How did you both meet and how did the fund get started?

Michael Blitzer (MB): Guy and I have known each other for a very long time. We both went to CBS. I was ’04, Guy was ’99. We didn’t know each other while we were at Columbia, but at that point AVI [Applied Value Investing] was a very small network.

Guy Shanon (GS): So everyone knew each other from different years.

MB: Guy’s class had six people. They were the only six people at Columbia who were interested in value investing — it was 1999. There was no AVI. The program really grew from there.

GS: Our initial investors and employees came from that network of students and professors.

G&D: We last spoke with you in 2010. How has the fund changed since then and what have you both learned?

GS: The fund has grown but the strategy and portfolio structure are exactly the same. We still run a long-biased and concentrated portfolio of special situation securities across the capital structure. Most of these securities are in the $1B to $10B enterprise value range for both equities and debt, though credit securities can be smaller. Being bigger also gives us research resources and access we just didn’t have when smaller, and the structure of the industry is making it harder for very small funds every year.

G&D: Why have you focused on that particular size?

GS: I think one of the things we learned is that it is not so easy to make money with super small caps. You see a lot of questionable management teams and very low quality businesses which have not become bigger for what are usually good reasons. Then of course you have all of the extreme technical aspects, like if liquidity dries up that makes it even harder. Yes, there are sometimes great opportunities, and we look at small caps all the time, but they aren’t giving it away by any means, and focusing exclusively can be a tough way to make money over long periods of time. We don’t think of ourselves as a big fund, and we think we can make the best risk-adjusted returns in the size range we currently target. The current portfolio runs the gamut from $300mm in market cap to $50B, so the range is wide and we look at everything. But the sweet spot tends to be this middle range which are small enough to still experience the technical factors that often lead to security mispricings but large enough to have quality of business and management. This size also tends to have a larger pipeline of the special situation categories we track like spin-offs and distressed debt.

MB: Also, there’s a big, timely debate right now about active versus passive investing. Passive has come into a lot of popularity. When we started twelve years ago, we maintained the premise that the markets are very efficient. Our strategy is to be exclusively focused on very small pockets of inefficiency within what is, generally, a very efficient market. We have to have the flexibility to go after companies that are smaller than $10B or $20B

GS: And don’t have twenty sell-side analysts covering them.

G&D: As the number of special-situation funds grew, how has this impacted Kingstown? Have you been able to maintain an advantage?

MB: The longer we do this, duration of capital and time horizon has actually become more and more of a competitive edge. We’ve always defined the strategy as kind of having a medium-term time horizon, generally one to three years. These securities tend to have larger mispricings. A typical example is a situation that has a known or likely catalyst but unknown timing — you know it will happen sometime in the next three years, but it could be tomorrow or it could be years from now. Given the structure of the hedge fund industry and the structure of capital, this sort of patience becomes harder and harder over time unless you align yourself with long-term capital. So we’re clearly shorter-term focused than a private equity firm. But there are very few investors in the public markets right now who can take a one to two to three-year time horizon. Most can hardly take a month or a week. To take advantage of most of the mispricing, particularly in the special situation space, you have to have that kind of runway. Also there is a lot of capital coming out of event-driven strategies, which overlap somewhat with what we do, this is very good for us.

GS: In the past twelve years since we started, time horizons have become a lot shorter. As students at Columbia and with the value-oriented internships you’ve had, you might not fully appreciate the low tolerance for volatility. If you go to some of these large multi-strat funds, time and volatility are very relevant because they’re running massive amounts of capital. In fact, they’ve attracted so many assets because they manage volatility so tightly. If you went to work there as analysts and you drew down a couple of percent in a month, you get stopped out.

But then what do you do with that cash? You have to find another trade tomorrow — is that better than staying with the business you owned the day before? It just feeds the volatility. I think the fact that we only focus on very specific special situation categories also makes us unique. We don’t do risk-arb for example. We are just looking at certain areas where we know there are chronic mispricings. A lot of fire directed into a small area. That is what we do. And we have been doing it for a while and it works, and we get better at it every year.

MB: In addition to size and duration of time horizon, it’s also been concentration. We run a fairly concentrated and flexible mandate where we look across industry, geography, and capital structure. We think it is also a big advantage that we can evaluate the risk-reward across these different areas and pick our spots very precisely. Then obviously we combine all of this with what we like to think is a fairly deep research process. But you can only do that level of research if you’re concentrated. When you group it together, these things differentiated the firm initially and have been consistent through the life of the business.

G&D: How did you develop and cultivate an investor base that allows for your strategy?

GS: From the start, we’ve been very conscious of the importance of having the right partners. I think it mostly came from some humility. We understood that it is very hard to beat the market and you need help from your structure and partners. You have to match the duration of your capital with your investments. Going back ten years, we’ve turned down money from people that didn’t share this approach. We’ve never had a formal IR effort. You end up with a certain type of partner by way of hiring a professional marketing person. We have personal relationships with all of our partners. We spend a lot of time talking to them about how they think about investing. Not surprisingly, most of our partners have a value bias in their portfolios. But investment philosophy aside, a direct relationship with partners creates more transparency for them and keeps the alignment of interests very close; sometimes having a marketing person between us inserts another agenda into the mix. We think our approach is best for our partners’ returns over the long run.

MB: It’s just taken time and a lot of energy invested in getting to know our partners and how they think about investing. We’ve gone through periods where, for many years, we didn’t talk to anyone about new capital. We also learned by watching what didn’t work for other funds. But ultimately this has led to a small group of partners who have stuck with us over time. And with less time spent on marketing and investor relations, there is invariably more time spent on investing and the portfolio.

G&D: Going back to volatility, how do you think about risk in your investments and how do you exit positions that are going against you?

MB: We mostly define risk as permanent impairment, which I think is very different than most people who view it in terms of volatility. We take the approach that risk and volatility are very different. A lot of the returns that we’ve made have been either averaging down or buying things that were down. On a short-term basis, it’s very challenging to time tops and bottoms. I think a lot of people have failed doing that. One of the approaches of having a longer-term strategy and longer-term capital is that you can withstand those periods of volatility and take a view over a number of years. Having said that, being very patient and permanent impairment often become the same thing eventually. We take the approach here that we are re-underwriting every single position every single day. If the facts change, we have to be intellectually honest and reevaluate that, otherwise you are just hoping. It’s a combination of research and portfolio management.

GS: It’s easier said than done, but when something is going against you, you have to fight off the urge to ignore bad news. As Mike said, be brutally honest with yourself whether or not what you thought was going to happen actually did happen or is happening.

Over the years, a lot of our former students have asked us about starting funds and how we would evaluate somebody who is starting a new fund. I think there are three parts.

There’s being a good analyst, and then there’s being a good portfolio manager, which is actually a pretty different skill set. Then there’s the third part, which is temperament. The big intangible. There are a lot of people who have one of the three or two of the three,

but it’s very hard to have three of the three because it’s a mixture of a bunch of personality traits that are not often on the same gene. But you need all three.

Part of temperament is being able to be self-critical. Many people in this industry have been very successful all their lives. They have always been at the top 10% of everything they have done. All of a sudden, a position is going against you and you have to really break it down and be honest with yourself. Or you have to take a view that is vastly different from what the “smart” people are saying, what your smart friends who are making money this year are saying. A lot of people have never done that before. You have to be very critical and skeptical all the time, but also know when not to be. And how you go about that has a big impact on performance over time.

MB: You have to put up walls and blinders to eliminate behavioral biases when these things happen. Of course, when something goes against you in a meaningful way, the market is usually not that wrong. At the very least, it’s down for a reason. Stepping back and understanding what that reason is. I think the only way to do that is through a constant re-underwriting process and a diligent research process.

G&D: Do you have any formalized systems or processes in place to eliminate these biases when making tough decisions, like a “pre- mortem”?

GS: Thinking, Fast and Slow is a great book. We’ve both read it. I read it over and over and I’m still learning, it’s not exactly beach reading. But we don’t have any formal framework. Anyone who says that they do, that’s more of a marketing gimmick. We’re very aware of the behavioral stuff, it’s important. It is possible that managing our own behavior effectively is the single most important thing we do as investors in public markets at the end of the day.

MB: Also the analysts here know that they’re not going to do well unless they start with the risks and the downside. Before we figure out how much we can make in an idea, we have to discuss what all the possible risks are that may or may not happen. I am not sure if I would call that a “pre- mortem.”

GS: Pre-Mortem? We see that term a lot, it’s part of a checklist that people interviewing for jobs have decided they need to have in anything they write, it has become part of hedge fund analyst culture, like it’s some kind of innovation. But really it’s common sense — if you are going to put a substantial amount of your net worth at risk, wouldn’t you think through how it could go terribly wrong, and what the first signs of that would be? The answer is yes, and it’s probably a good idea to write it down.

MB: It’s also a little naïve. When most people have lost money, us included, it is often not from any of the twenty possible risks you listed in advance. When the bad outcome happens, you’d be shocked how often it was related to something that wasn’t on your original list. For us, this is why it all comes back to valuation. Being a good investor requires you not only to be wrong in ways you didn’t anticipate and still not lose a lot of money. I think the only way to do that is to buy things very, very cheaply. For most investments that haven’t worked, we have been very wrong on a number of things and still not taken a large impairment.

GS: I think that’s called “margin of safety.” The closest thing we have to a formalized process is our emphasis on written memos. For any position of a decent size, we write very detailed memos.

We date them and we update them, so that six months or eighteen months later we can go back and see what we thought was going to happen. From a psychological standpoint, you can play all kinds of games if your investment ideas are all in your head, which is bad for performance.

MB: It also makes you refine your thinking. By writing something down you are forced to focus your thoughts in a way that verbally you cannot.

GS: Yes many times I have had this experience: I decide I like something, then I write down the bull and bear cases for it, go back to it a few times over several days, adding things, and then I think, you know what, I don’t like this so much anymore. Writing things down brings more precision to your thinking and helps in the

process of weighting factors. Often we all have very similar information, but the rub is, how do you weight it differently in a decision to get better outcomes, that is the Kahneman stuff too. You should get better at that every year and as you live through more things. But then again, you don’t want to be over- influenced by an unusually good or bad experience, because outcomes are more like the mean than the exception — again, Kahneman.

G&D: Would you mind walking us through an investment from the screening and search process to actually putting capital to work?

GS: As we discussed earlier, our view has always been that the markets are very efficient. They get more efficient every year. There are lots of smart people out there working on lots of names. We have to ask ourselves, “Well, how are we going to make money in a market that is generally efficient? How are we going to do it consistently?” Anybody could do it for a short period of time. We have to look in places where there is chronic mispricing. You have to keep looking in those places over and over again. You have to keep the fund size small because the bigger you get, the fewer places you can look. All we do is look at a couple of areas of special situations. We look at every spin off. We look at every bankruptcy or stressed credit. We look at every rights offering. We look at every privatization. Anyone can get a list of these, but we are really, really looking at them, pulling the threads for a thesis that might be missed by most others. If you just keep looking at these categories and you own the good ones, unlevered and at good valuations, and you can be a little patient, you have a good chance of outperforming in the market. How does an idea go from there to the portfolio? I think we are unique in that we screen for situation first, not valuation. What you might find is that a lot of value guys will just look at the new lows list. There are reasons that’s dangerous, the biggest being value traps. First, we look at the situation and see if there is somebody stampeding out of the stock or bond. Do we understand why? Yield breaks are good examples. Every time a yield equity or credit is downgraded, there are obviously structural reasons why people have to sell. That will pique our interest. Then we’ll start looking at valuation on an absolute basis, to the enterprise. We don’t use relative valuation here. If the valuation on an absolute basis is cheap, then we start doing fundamental research, which includes a lot of primary research. And the primary research is something we have gotten better at over time, it’s something you only improve at by doing over and over and figuring out ways to gather but also prioritize information. If it’s a liquid equity, we’re not in a rush to buy it. We’ll have a fully blown research process first. We’ve met with management, interviewed a large number of former employees, done a lot of work on business competitors. We’ll do that before we own it.

Credit is different because it’s such a choppy market.

Sometimes we’ll own credit when we’re pretty sure it’s good. We’re 90% sure, but we have to take advantage of the liquidity at that moment and then we’ll backfill our work.

You also have more structural and legal protections here if you are wrong. Generally, we’re fundamentally driven and we know the investments very well before we buy them.

G&D: Is a position fully sized at this point in the process?

GS: A lot of times what we’re doing is averaging down because we own something and it’s the exact opposite of momentum. So we save room to average down.

I think we are also unique because Mike and I work on the names with the analysts. The two of us are intimately familiar with everything in the portfolio. I think that’s important because at a lot of funds, if a name goes against the portfolio manager and he or she is reminded they just don’t know much about it.

Then they look to the analyst and ask, “Is the analyst good?” Then they start thinking about the idea in the context of the analyst. “How has the analyst done recently?” This actually reduces to a kind of momentum that analysts get inside funds, which influences investment decisions and is kind of crazy when you step back and think about it. We are trying to reduce the behavioral stuff between us and the idea, and want to be right there on the front line. We want to be fully informed and decisive. We don’t have to wait for a committee meeting or consider the internal politics of an investment decision, because we have neither of those.

G&D: Do you have an investment idea you want to share?

MB: Our largest position right now is Adient (ADNT). ADNT is the largest manufacturer of auto seating in the world and virtually every auto company is a customer. Johnson Controls (JCI) spun out the company in October of last year. From an initial search process, it’s an example of something that struck our interest given the structure and nature of the spin off. It was a much smaller subsidiary, it was in a different industry, and it was an underinvested business of the parent. It’s also a very misunderstood business. Like many of its auto part competitors, it’s viewed as a very low quality and cyclical business and thus not favored by JCI investors. This bias along with a lot of forced selling, because it is no longer part of the S&P 500, pushed valuation to approximately 4x to 5x earnings late in 2016. But, if you look at the company, there are many competitive barriers to entry in an industry dominated by two main players and the business is actually more of a high-return just-in-time logistics provider and supplier than an old-line manufacturing company. The prior Vice Chairman of JCI is the new CEO of ADNT. He has a very significant compensation package that he converted from JCI that we think aligns well with future growth opportunities. Incidentally, one of the biggest knocks against ADNT and a lot of the auto companies is the disruption and potential change in the industry. But ADNT is a big beneficiary of the move to autonomous vehicles. Number one, they have a position with every single manufacturer. So, regardless of how market share changes with autonomous driving technology, they’re — bad pun — going to have a seat at the table. ADNT and Lear (LEA) control a majority of the global market. As these vehicles become more autonomous over time, one of the big differentiators is going to be the interior package, and seating is the biggest component of that. We like the business a lot. In an equity market that generally is pretty fairly to over-valued, it’s unusual to get an above average business for a third to a quarter of the S&P P/E multiple. But I think it also fits in well to what Guy was saying about the search process: how the name was identified, what we like about it, why it was mispriced, and how that flows through the process.

G&D: How concerned are you about the auto cycle and where we sit today?

GS: That’s the bear argument, but there are two parts to it. First, the industry is cyclical in general. Then there’s the idea of a SAAR Wall. That is the classic bear argument. We don’t think SAAR is going to plummet. There are a lot of people with short term trades based on where SAAR will move. We think SAAR levels out at around 17 million in the United States, but quite possibly more. Regardless, ADNT can make a lot of money with SAAR just sitting where it is right now or if it falls somewhat. ADNT also makes a good amount of revenue outside of the U.S. The dynamics of production in Europe are different. There are reasons to think that production can grow in Europe. Also, even the skeptics say that China is going to grow car sales for a long time, and ADNT is generating a good amount of its cash flow from China. The other interesting wrinkle is the growth in content per vehicle. In an extreme case, they can triple content per car in some markets over the next five or so years. Even if unit volume decreases, it’s possible ADNT can actually grow sales.

They are also making real progress selling seats into non- car markets, like trains and planes.

MB: Units aside, the trend for interiors is towards bigger cars and higher value content.

That’s all to the benefit of seating. If you look at autonomous concept vehicles, the entire dash and driver display is stripped out, and the interior is basically four high- end seats like a living room.

Unless people start sleeping or standing in cars, ADNT will be a beneficiary of this change.

Adient also has a pretty significant opportunity to go into adjacent markets, whether it’s train or aerospace or more industrial applications. They historically have not been able to invest in these areas because of capital constraints while under the JCI umbrella.

On the unit volume issue, at least in North America, there are cycles, but the growth over time is still up and to the right. It is a function of cars on the road and population. The common mistake is to look at units pre-financial crisis, which was nearly ten years ago now, and to think that SAAR has to go back to that number. But there are so many more people and units required at this point. If you look at it on a replacement cycle basis, it’s unclear that even the current level of units can sustain that demand.

Yes, it is certainly a risk. There is certainly a cyclical component. But the geographic diversification and the significant tailwinds they have in content and technology and where cars are moving are major pluses.

GS: The reason the opportunity exists is exactly related to your question about the cycle. If you went to your PM at most hedge funds until very recently maybe, you would be told that you can’t be long auto because SAAR is “peakish,” in fact can you come back with some shorts here. Maybe we get some bad numbers on SAAR over the next several quarters — we aren’t saying that won’t happen. But this is a business that should grow sales over the next five years. As a private business that is how it would be thought of, and we try to think about it that way within the practical limits of being a public market investor. We do have this moderately hedged because of Trump Risk. We could start having issues with Mexico or China where the Chinese get mad at us and try to penalize us with auto somehow. And, as Mike was saying before, it’s always the thing that you didn’t see coming.

G&D: Now that ADNT is independent, how will this impact the business?

MB: We think ADNT is going to generate $9 in earnings this year. Their margins are a lot lower than Lear’s despite the fact that ADNT is significantly bigger and there are real benefits of scale in this business which favors large global platforms supplying very large customers. These lower margins just relate to under- investment in the business while controlled by the prior parent. Management has a plan over the next couple of years to at least match Lear’s margins, which at current volumes would take them from $9 to $12 or $13 a share or more. This was a stock that got as low as $45 in November and is still only $60 today. I think it’s a unique example of being able to purchase something with a pretty attractive growth opportunity at a mid-single digit earnings multiple G&D: Lear and Adient control most of this market. What does the competition between the two of them look like?

MB: It’s been very rational. The good news is that they’re both big public companies.

They both have margin targets. It’s also a business where very few awards switch between the two of them. The incumbent has such a significant advantage in this industry because winning business requires you to spend a significant amount of capital and build your plant within the physical confines of your customer. When work is re- bid, the incumbent is always going to be at a cost advantage.

The only time you see platforms switch is if there’s a move in location or a massive re-engineering of the platform. Traditionally, most of the significant competition has been on new platforms. Even then, there has either been enough business to go around or the share has come out of smaller players. Outside of North America, the majority of seating is still done in-house, so there’s still a big opportunity to outsource more to both Lear and Adient.

GS: Returns on capital for both companies are OK over a cycle, and these businesses and

the industry have changed so it’s not clear that the future will look just like the past if unit volume goes down with respect to profitability — it’s quite possible return on capital prospectively is much better, which does wonders for a stock price.

MB: Seating is one of the better auto supply businesses to be in, but there have also not been stand-alone businesses historically. Pre- financial crisis, these businesses were grouped together with a bunch of lower-quality, lower- return businesses like interiors or metals or other commodities. We are in a unique situation where you have two seating-focused companies and everyone assumes their performance is temporary and cyclical because these types of companies have never been able to sustain returns for very long. But it has always been the other businesses that have taken them down in past cycles.

GS: The other interesting thing is that this is a very low gross margin business, which if you were a new value investor, you might say, “Oh, that sucks, it’s a bad business.” But it’s actually pretty good because the gross margin is mostly low because most of the costs are passed through to the customer, yet it discourages other competitors from getting into the business. With two companies that control a majority of the business in a low gross margin industry, there is not a screaming siren saying “Come compete with us.” The seat, in part because it’s so safety-centric, is a very important part of the car and it’s also not a big part of the cost, which also discourages the OEM from trying to kill them on price and creates some stickiness.

MB: There is no investment that is without risk. But paying 4x earnings eliminates a lot risk.

G&D: You mentioned hedging this investment. Can you talk specifically about this and also Kingstown’s overall shorting strategy?

GS: Our short exposure is generally zero to 25%. The majority of our hedging is where we think we can isolate industry risk. We want to be very specific, we’re not looking to hedge the volatility of a particular name. We’re looking to tease out some exposure that may worry us. Usually you can’t do it, that’s why we don’t do a lot of them. For ADNT, some of the things that we worry about will also hammer Lear and some other auto part suppliers, so we’re short a couple of them. But we still have a very meaningful net exposure to ADNT.

G&D: Is there a component to your short book that is not paired with your longs?

GS: We do some alpha shorts, but we don’t do a lot. We don’t have a formal process for it. Sometimes in our work on longs we find something that is a screaming short. We’ve actually made a good amount of money in absolute terms on our shorts over time. Because, unlike a long-short fund, where you’re under constant pressure to maintain a certain short exposure, we don’t have to keep loading the short book with God knows what. If we think something is ridiculous and we’re trembling with greed, we’ll do it. Otherwise, we’ll just do nothing. That’s kind of how we think about it. G&D: You tend to look for things that you feel have bottomed-out but you’ve also mention that timing is incredibly difficult. How do try to manage these two elements?

GS: We’re not an algorithmic strategy, so the answer is that we just don’t know and we just do our best. Sometimes we bought something all the way down and we just have to stop. Sometimes we buy something and it goes up 50% and it was small, because we never got the chance to make it big. Both bad scenarios. After doing it for a while, we just assume it all averages out. We’re not going to own something unless there’s some reason to think it’s really misunderstood or really overlooked, and we are confident the market is wrong, that’s the bottom line.

MB: You have to use valuation as an anchor. That’s not to mean something like ADNT, trading at $60 and 5x earnings can’t go to $45 and 4x. Things can always get cheaper, but Joel Greenblatt used to say that it’s more binary. Things are either cheap or they are not. And if its cheap you should just buy it. If you can make a lot of money and you have a significant hurdle that you’re reaching for, it should be pretty clear. Back to Guy’s point, that doesn’t mean you never can lose.

GS: When we say “bottomed out,” we mean more sentiment

than valuation.

G&D: Could we talk more about privatizations and some of the unique features? Perhaps talking about specific ideas and case studies would be helpful.

GS: Privatizations are interesting for a couple of reasons. First, they’re usually state-owned enterprises, which means that they’ve been poorly run. So there are usually opportunities once you get a real corporate governance structure and management incentives. Then they can take out a ton of costs or do things that should have been done ten years earlier. That is not always the case, but if you look at ten privatizations, you’re going to find one or two like that. Second, they tend to be unlevered because they were owned by the government. We hate financial leverage. We have no leverage on the portfolio. We’re usually carrying net cash and most of the companies in the portfolio are not levered so that really should help us in any kind of downturn. Third, these tend to be strong, monopoly-type businesses. It’s the railroad, it’s the mail delivery system, it’s the electric companies.

G&D: The stock exchange?

GS: Yeah, it’s companies that are incumbents because they were originally funded by the state. The international aspect is very tough. You have the currency issues. But more importantly, you’re always the guy who knows the least. You’re the idiot foreigner who doesn’t necessarily understand the culture and, by the time you hear about something, everybody in the country has heard about it. The bar for us to invest internationally is definitely higher.

MB: Sometimes you have some interesting incentives. If I take my tech company public, I want to get the highest valuation possible, because my net worth goes up. When the state owns the business, they don’t necessarily care that much about the IPO valuation. They just want people to say that the privatization worked out well and the stock price went up after the IPO. It doesn’t really matter what the base point is. They’re similar to spin offs in that you often have a non- economic seller, a misunderstood situation, and a number of catalysts, that Guy mentioned, for future improvement. I don’t think we want to talk about the specific name, but an investment we made recently was in a railroad company in Japan with a monopoly business in a certain part of the country. The government priced the IPO artificially low because the entire purpose and mandate for this privatization was to spur local retail ownership in the stock market which is currently very low. Their primary goal was not to raise the most money possible. The primary goal was to spur investment in the stock market by locals and to have a successful track record so they could do this again in the future. Then you take a business that was being run for no profit historically, because the mandate was just to allow for cheap travel. Now, with a profit maximizing management and aligned incentives, it can lead to a business with much better economics in the future than existed in the past. But some overlook this opportunity and other privatizations because all you can see is the historical performance.

G&D: Outside of not finding the right valuation, what are examples of privatizations that are not good investing opportunities?

MB: There are big differences in the businesses that are privatized. Buying a monopoly railroad in a specific country with no competition is very different than buying the state owned oil company. Even though it may be the only oil company in the country, it still operates in a globally competitive industry. It basically comes down to how much control the government has over it and whether the market is local or global. The last thing is related to the incentives of the government and the new management team. In the past, there have been privatizations that were vehicles for governments to raise capital from foreigners, but still maintain most of the economics without shareholders benefiting.

G&D: Do you have any advice for students and other people entering the industry?

GS: I have two pieces of advice: One, I would say it’s a good idea to listen more. Analysts in this business, they get to a meeting with management and so much of it is about promoting themselves. Let’s face it, what are you taught at Columbia or any other business school? You’re taught to network and to promote yourself. Students and former students view every interaction as a way to show how smart they are. People actually spend so much of their energy in a meeting talking but very little listening. I’ve had so many experiences where someone comes out of a meeting and only absorbs 20% of what was said, and it should be closer to 80%. Instead of thinking about your next question or insightful observation, just listen. It may lead to something else that is useful even months later, or stick in your head forever. These are simple things but if you want to become a good analyst, you can benefit very much from doing it. It also helps in the rest of your life. I tell myself there is going to be a test after every meeting and I need to retain like my life depends on it. It really works. Listen with your ears, not with your mouth!

Two, for interviews, we meet hundreds of people who share investment ideas and they all sound exactly the same. It’s very rare that somebody comes into a meeting with some kind of actual insight. You get a unique insight because you have been thinking about this information differently or you found new information through primary research. You visited 25 stores, you met some customers, you filed a FOIA request, whatever. And it led to some kind of insight. If you can do that, you’re going to have a lot more success than most of the candidates will. Any monkey can generate EBITDA multiples and slap them on slides with bullets. More kids are going to undergraduate business school than ever before. There are thousands and thousands of people who know Excel and have taken Finance. You are not going to set yourself apart that way or be successful, and even when you get the job, these are the kinds of things you have to keep doing and get better and better at.

MB: It’s a weird industry because unlike most other professions, there’s no specific experience required. My advice even for MBAs is to appreciate how much you don’t know and to find a place where you can learn but also where you share a common investment philosophy. If you don’t have a common philosophy with the fund and a real passion for investing, it’s not going to work. You can’t fake passion and fit. Also, given the popularity of hedge funds over the past decade, a lot of people have come into this industry because it's the next logical step or the way to become wealthy. It’s what Investment Banking was before that. So it has attracted very high performing individuals many of whom have never experienced a setback or disappointment. But, this business humbles people very quickly and how you deal with these initial setbacks will determine success or failure. So we end up focusing on and asking about these disappointments when we interview these high performing candidates that go from the Ivy League to bulge bracket Wall Street firms then to hedge funds. The setbacks and how they have learned to think about risk and reward and their lives in general are what differentiate people in our experience.

The only other thing that we tell every person that we've hired, no matter how old or experienced he or she is, is that you have to bring a notebook to every single meeting and you have to write everything down. You'd be shocked how few people do that and how helpful it can be. You'll never miss something and if you do exactly what your boss wants you to do, it'll put you in the top 10% right out of the gate.

GS: Are you guys writing this down?

G&D: Thank you for your time.