Clay Finck (02:47):

You hear all the time that value investors, they want to find an asset, determine what it’s worth, and simply buy it for less than its worth, or put another way, to buy an asset for a price that’s less than its intrinsic value. Within your value investing strategy, what do you think makes Oakmark’s strategy different from other value investors?

Tony Coniaris (03:11):

I’m glad you asked that. There’s a couple of things. Let’s go back to the first criteria, significant discount to intrinsic value. That sounds pretty humdrum value, but it’s really not. There’s two really important words that are differentiators in there. The first word is “significant.” There’s a lot of value managers, and again, I don’t mean this as a criticism. I’m just trying to make a distinction here. There’s a lot of value investors that require a discount, right? Any discount, and that’s fine. They can do what they want to do. We require a significant discount, significant margin of safety in the Seth Klarman vernacular, and that’s a differentiator. By significant, I mean a 30% or more discount to value. Okay? That’s a big one.

Tony Coniaris (03:47):

The second important word is “intrinsic.” So there’s lots of ways to do the value thing. There’s statistical value. There’s relative value. We don’t do either. So what we do is take a private equity approach to valuation. What are the future cash flows of the business? What kind of a discount rate is appropriate for the business? Value the company as if you were going to buy it outright, and is there a significant discount to that? What does that do for us? It frees us up a little bit because we can look at businesses a little differently.

Tony Coniaris (04:14):

For instance, growth is a component of value. It’s not exclusionary like it might be for a value manager that just looks at a certain index and says, “I can only own what’s in this index.” We look at the world as a little more broadly and think, “Well, if a company is growing and of high quality, that’s not off limits because it’s at an average or above average price. It might be worth well above average price.” In which case, it is a real value.

Tony Coniaris (04:36):

Secondly, we do have a quality filter, and there are a lot of cigar-butt-type value investing out there, and you can do well doing that. We choose not to. We look for things that have underlying growth in the business and that have a clear path to earning above their cost of capital. You think about every business requires capital. If you put a dollar in and get 80 or 50 cents out, that’s not going to work real well, and so we want to make sure that our businesses have a real moat that allows them to earn a good, fair return.

Tony Coniaris (05:06):

Then thirdly, this management criteria is really important. When you buy businesses at low prices and hold them for long periods of time, what management does with their capital, like how they reinvest, how they allocate capital really matters. You could imagine buying a company at 10, 12 times cash flow and holding it for five years. You could get back 50%, 40% of the enterprise value back in free cash. How that’s invested or distributed really matters. How they take care of customers and employees really matters, and so what management does is really important to us, and we interview our management teams. We want to make sure that they have skin the game and are on our side.

Tony Coniaris (05:44):

Why do a lot of value managers ignore management teams? I think some do it because it goes back to one of Warren Buffett’s old comments of, “You want to own a business a monkey can run because a monkey will eventually run it,” and there’s some truth to that. On the other hand, we don’t want to invest our clients’ capital in a company run by a monkey. So we’re just not going to do it, and that’s just us, and there’s different strokes for different folks, right?

Clay Finck (06:08):

Now, looking into your background, you’ve been in the investment business since 1999. I’m curious. Has valuing companies become more difficult in the low interest rate environment that we’re in that really just elevated stock prices at least to some degree?

Tony Coniaris (06:24):

I wouldn’t say it’s more difficult to value businesses, but I’d say it’s harder to understand the valuation that businesses are receiving in an interest rate environment like this.

Clay Finck (06:35):

If valuing businesses hasn’t become more difficult, has it become more difficult to find those companies that are trading at attractive valuations?

Tony Coniaris (06:44):

That’s a good question, and when you look at the market and aggregate it, it looks like pretty expensive, right, on the surface. If you look underneath the covers, there’s a lot of dispersion in the valuations out there. There’s a real story of haves and have-nots, and there’s a variety of ways to look at this. We choose to look at value dispersions like, “Where are the highest price stocks valued versus the lowest price stocks?” That is significantly out of whack with where the market normally is, and you can argue about what’s driving that, what’s not driving it. I don’t really know, but I know it’s there.

Tony Coniaris (07:16):

It may be interest rates. It may not, but it’s there today, and that means that even in a market that on the surface looks a little bit more expensive and therefore, investors should probably have lower expectations, under the covers, if you’re picking the right companies, you can buy great growing companies with great returns, above average returns, above average growth at pretty terrific prices today. So it’s this dispersion bifurcation in the more market today that’s providing opportunity for value managers like Oakmark.

Clay Finck (07:44):

Yeah. I think that’s a really interesting perspective, and I hear you guys say a lot that you have this bottoms-up investment approach. I think some people that are maybe newer to investing might question, “Okay. What does that really mean?” So could you talk a little bit about what a bottoms-up approach is versus the opposite, a top-down approach?

Tony Coniaris (08:05):

Okay. So this is all I’ve done my whole career, so I’m going to do my best to answer this. Two things. Okay? The first one is we’re benchmark agnostic. There is a way to be a… You can be an “active manager,” and one way it’s done is you start with the index and you say, “Here are the sector weightings,” and I don’t want to be that different, but I have a view within the sectors of, “These are the five best stocks, and I’m not going to own the sixth,” or, “I’m going to overweight these relative to these in a minor way to try to be a little bit better than the index and justify my feed.”

Tony Coniaris (08:35):

So that’s not being benchmark agnostic. We are. So we look at every investment individually, iteratively for the portfolio. It doesn’t mean we don’t consider diversification. We do, but everything we do is like, “What is the discount to intrinsic value? How much confidence do we have in the people and the quality of the business and the investment case?” and then weight them accordingly. So again, that’s what bottoms-up means. It means you’re doing things with no regard to where the index is and you look very different. You can’t be better if you’re not different, right? So that is an important thing.

Tony Coniaris (09:03):

The second thing is… and this is just my view. Again, I could be wrong. There’s no macro overlay at Harris Associates that says, “You can’t own this. You can’t own that because we think GDP is doing X, Y, Z, and consumer health is going this direction or that direction.” So we don’t start with trying to forecast a very dynamic global economy. We start by looking at each individual company, and the way the economy gets factored in is what are the facts and circumstances today, and what has this business done over time through business cycles? Then, dollar average the profitability of the business and the cash flows of the business for those ups and downs. So like a private equity investor would do, if you’re buying a business, you’d say, “Yeah, they have one bad year for every six good ones. Let’s smooth the earnings out for that.” That’s the approach we take rather than trying to predict when that downturn is going to happen and try to time the stock that way. The market does that for us by taking stocks down when they’re concerned about things like that.

Clay Finck (10:01):

In your funds, you’re pretty heavily weighted towards financials, and my guess would be that the financial sector is just trading at a really attractive price, and they’re producing those consistent free cash flows, and obviously, have good management, and meet your other criteria as well. So it’s not that you guys necessarily like the financial sector. You just see that there’s better value there relative to other sectors is the way I would interpret that. Is that right?

Tony Coniaris (10:27):

The best way to think about when we have an outsized exposure, it’s because our bottoms-up process has led us there, and there’s a variety of reasons it led us into the financials, but I think the more important take takeaway is that from time to time, we’re going to look very different because of where the opportunity is, and sometimes it’s bunched up. That’s not totally abnormal for a bottoms-up value investor. It doesn’t have to be a top-down view. It can be a bottoms-up view where the value is just simply very bunched up.

Clay Finck (10:54):

Why do you believe that the financial sector is beaten down relative to some of the other industries?

Tony Coniaris (10:59):

A couple of things. Number one, if you look at the income statements today, they’re earning below their potential, and that’s not fully appreciated, and part of that has to do with interest rates. We’re in a very unique period of time here. If you look historically, it’s not a leap to think that the real return on the risk-free rate would be about zero or slightly positive, and we’re nowhere near that. That would be a significant positive for financials, which is just not reflected in their values. Then, the combination of capital return, which again, we don’t believe is fully reflected in their values as well as the improved balance sheets. They look pretty attractive to us today, so we have pretty large basket of value stocks in most all of our portfolios.

Clay Finck (11:39):

Let’s transition to talk about a pick that some people might question whether it’s a value pick or not, and that’s Netflix. It’s similar to some of these other companies you’ve invested in that are higher growth, call it Facebook, Meta, or Google. Netflix is another one of those names that’s higher growth that’s in your funds. Could you talk to us about what the investment thesis is on Netflix and how it qualified as a value investment for you guys?

Tony Coniaris (12:05):

Yeah. I think this is where we’re showing our true intrinsic value stripes. You may not see the value on the income statement. It may not be readily appearing, and Netflix is one of those companies. It’s not necessarily because of the amount of spending they’re doing. It was really, at the beginning, for us, it was about the revenue line. The way we’re thinking about Netflix is I think we all can agree that the media business is moving video, especially moving towards streaming, right, from linear television. Netflix has a huge lead, and it’s transition from a more local media business globally to much more of a global scale business. Again, there, they have a significant lead. So there’s going to be more of a winners-take-most type of situation in the media business in the future than there has been in the past. Like I said, they have a huge lead, they have a scale, and they have the management team in a very unique culture that we believe is going to keep them there.

Tony Coniaris (12:55):

So that’s the big picture view, but the value has to be there. Right? We’re value investors. In 2017, when this was originally presented as an idea and was purchased, the most glaring signal of that hidden value you’re not seeing on the income statement was in the price of its product. One of the most memorable comments our analyst made at the time was, “We all have Sirius XM in our cars and know how much value we think that provides us. Think about your Netflix. Well, it’s priced much lower than your Sirius XM. If you just priced it there, Netflix was trading at 14 times earnings, pretty good value, right, and not apparent when you look at the income statement, but there.” Shortly thereafter, they started catching up on price. Meanwhile, reinvesting in content and building their user base across the globe. So, today, what we’re tracking is this continued growth in users and subscribers, and the margin leverage. They’re beginning to lever the margins and profitability on this globally, and you’re starting to see the benefits of that scale.

Clay Finck (13:56):

I pulled Netflix up on our TIP Finance tool, and I was definitely impressed with the top line growth, as you mentioned, and brought it up in 2017. Since then, you’ve had revenues of 15 billion in 2018, 20 billion in 2019, 25 billion in 2020, and nearly 30 billion in 2021. Obviously, a growth machine. I came up with an annualized growth rate of 26% since 2012 for the top line. Is it just the international growth that will be the driver going forward, or what do you expect there?

Tony Coniaris (14:28):

Yeah. So the way I would break this down is we know where the growth won’t be. Okay? Let’s start there. Process of elimination. The US market, while there’ll be some price and they’ll continue to invest and deepen those relationships, the US market is pretty well-penetrated. Internationally, very under-penetrated, and some of the markets are more mature than others, and they, from time to time, give us some view of the scale there. But as you deepen the content and deepen the relationship with customers, you can charge more, and they invest ahead of that to get users and subscribers.

Tony Coniaris (14:57):

So that’s the model, and what you have is you have 220-ish million global subscribers. The way we’re thinking about the opportunity here is for growth is you’ve got roughly 800 million globally broadband connections. So what is that? A little more than a quarter penetrated. So the growth, you’re right, has been terrific, but we see more upside from here, and it’s going to be a combination of leveraging markets they’ve entered, and entering new markets, and building those markets out. Some will be invested ahead of, and some will be more in harvest mode like the US.

Clay Finck (15:30):

It’s interesting to think about the international business. As many areas of the world won’t be priced as high as the US market for their subscriptions, as far as the price action on the stock, it’s been a bit of a rollercoaster ride. The stock was around $380 a share pre-COVID in February 2020, rose all the way to $690 a share in November 2021, and now we’re back down to $360. So below the pre-COVID share price. What do you make of the rollercoaster ride of the shares over the past couple years?

Tony Coniaris (16:04):

Yeah. Good question. There’s a lot in there. I think just to keep it brief, what we saw and part of the reason the stock did what it did in those periods was this was a COVID beneficiary. It pulled forward subscribers that may not have come in in 2020. They may have been a 2021 or 2022 event for Netflix, but they got over the hump because they were at home with nothing to do. So they pulled forward subscribers at the same time. In the income statement and cash flow statement, you see a temporary positive of you could not develop content as fast as you could pre-COVID because there’s all these rules. You got to wear masks. You got to be in this room. You got to isolate, and blah, blah, blah, blah, blah.

Tony Coniaris (16:42):

So they slowed down production. At the same time, they accelerated their subscriber growth, and what that did was it… They’ve been growing margins roughly 300 basis points a year, and they grew almost 500 basis points in 2020. Meanwhile, subscriber growth also accelerated, and that on the capital side, there was less new content creation. So the free cash flow exploded, and so you had a very temporary bolus of profitability pull forward and subscriber pull forward.

Tony Coniaris (17:10):

Today, we’re dealing with the hangover of that, and then there are some other things compounding it and scaring people, like we’ve had this clockwork increase in margins. One of the things you should be tracking, it’s not just user growth, but also profitability, and we’re going to have a setback in the margin trajectory this year. Part of that is because we had an above average last year. So if you look at this business over multiple years, like you said, it looks like just a machine, a clockwork, but we’ve had these extenuating circumstances which have led to some volatility in that trajectory, and that’s fine.

Tony Coniaris (17:40):

As a long-term business owner, you wouldn’t be too worried about it. But again, another thing going on this year is currency, and this is something that they can adapt to over time. It isn’t a long-term impact, but it’s had a real impact on the margin. Something like two-thirds of the margin impact this year is going to be a result of currency translation between producing in dollars and selling in euros, and realizing your subscriber revenues in euros, but you’re producing in dollars. That has a negative impact translationally on the income statement. That’s not permanent, but it’s having an impact, and I think people are confusing the cyclical with the secular.

Clay Finck (18:13):

Yeah. It’s funny you mentioned that a lot of that growth was pulled forward in 2020. I look back. April, May, I was watching a lot of Netflix because there really wasn’t anything else to do. All my gyms were closed, and I can’t go out and see all my friends and everything. When I think about Netflix in my own life, I’m chatting with my friends. You got one new show coming out on HBO. You got another new show coming out on Netflix. So there’s almost this fragmentation of the market, and it makes me wonder what sort of moat Netflix has and if they’re able to stick around and keep people paying for their services. What is the competitive advantage or moat that Netflix has that maybe others don’t?

Tony Coniaris (18:53):

Yeah. Well, it starts with their lead, right? You have the scale, and they’re in a position today where they can afford to provide more content value by having a big content budget at a lower price. That’s really powerful, right? That’s a true benefit to the consumer, and as long as they continue to keep that relationship in a good spot, they’re going to continue to grow their consumer base. That’s a very powerful thing, and they have a great lead.

Tony Coniaris (19:18):

As for competition entering, very cognizant of that, understand that. On the other hand, think back to the cable industry. We went from three channels in this country to 150 or something on average, right? It was a great industry the whole time, and it’s a very large industry, and it’s something. People like entertainment. They’re going to want to be entertained, and it’s not going to be one company providing their streaming in the future just like it wasn’t in the past. It fragmented, there was lots of channels, but it was still a very good business because the pie was so big. The pie here with the transition from not being as local, but being more global, and back to everything we talked about with the growth opportunity, there’s just a very long runway, and there’s a lot of room for more than one company to win.

Clay Finck (20:03):

You mentioned that you like to analyze the quality of the management pretty closely. What are some of the things you’re looking at for Netflix in assessing the management?

Tony Coniaris (20:13):

Well, we like the management team, so we’re obviously monitoring turnover. Right? We wouldn’t like to see a lot of turnover at the top there, and then the performance of the business. I mean, they’ve really not given us a reason to question them. They’ve made some really important transitions from DVD to streaming and et cetera over time, and I think they just have a very unique culture, and we want to see evidence that that remains intact. Right? Not many management teams have almost like a manifesto of what it means to be a Netflix employee, which they have. It’s just a very unique group of people that are really focused on growing the value of this company over time the right way.

Tony Coniaris (20:46):

Things we’re tracking. Like we talked about before, subscriber growth, continuing to chip away at that international opportunity and continuing to show that this business model works by demonstrating leverage on the P&L because they are big enough to show some leverage and they realize that. They’ve committed to about 300 basis points a year, and they’ve been on this trajectory, recent hiccups not withstanding where 2020 was above that and 2021 will be below that. They were at a conference the other day and said they fully expect to get back to that trend line, which means there’s going to be a catch-up in margins here. So we’re going to track the growth and the profitability. You need to look at both of them to be testing the business model to make sure you’re not just growing at any cost.

Clay Finck (21:27):

For a less sophisticated investor like myself, I look at the income statement and the numbers. I see negative free cash flow in some of the years in the past, but you mentioned earlier that if you adjusted the pricing for Netflix, you’d get a 14 PE. So we may be seeing positive operating income, but negative free cash flows. What’s the reason for the disconnect on that front?

Tony Coniaris (21:50):

Yeah. The disconnect is when you’re growing, it’s like any company. So if General Motors was, let’s say, in the ’50s was growing 20% a year or something like that, their capital expenditures are going to be above their depreciation. So cash flows will be less than earnings. That’s true for any business. It’s also true for this, where you spend up front on the content, you amortize it on the income statement. So because you’re spending 100% on the cash flow, and you’re growing, and you’re amortizing a third or whatever of that content on the income statement, there’s going to be a disconnect there. It doesn’t mean that the assumptions are aggressive. It’s a reflection of the growth, but they are cash flow positive today, and they are… This is a very interesting and strong signal. The company is actually buying back stock today. They haven’t done that for a long time, and that’s a signal that these very smart managers think their stock is undervalued.

Clay Finck (22:39):

So you guys are making adjustments to the earnings based on the CapEx. Are there any other adjustments you guys are looking to make or… Yeah. How do you think about that?

Tony Coniaris (22:49):

It’s not so much adjusting what we’re seeing. It’s understanding and reflecting the full potential of what will be in the future. So it’s how much upside is there on the subscriber base, right, over the next few years, and what’s the leverage on the P&L going to look like? What does that mean in terms of cash flows on average over time, and what does it look like at maturity? So that’s the math we’re doing. The adjustment we were doing originally when we invested was just to highlight that this was significantly underpriced. But over time, they’ve been raising the price and using those dollars to reinvest in other markets to acquire more subscribers, so that part of the… It’s not true today that if they brought the US prices in line with Sirius XM that it would be a 14-times earnings. That was a point in time. Today, it’s much more about chipping away at that 800 million broadband subscriber opportunity that’s out there from a base of 220 million and meanwhile, having a good balance of reinvesting to acquire subscribers and showing the P&L leverage.

Clay Finck (23:50):

With that, what do you believe is a fair value for Netflix or maybe the intrinsic value, and how you came about that number?

Tony Coniaris (23:59):

Well, we don’t get into specific numbers, but the way we’re thinking about this, I go back to what I said earlier, which is there’s an 800 million broadband subscribers globally. There’s a couple billion, many billions of mobile subscribers. We’re not even touching that when you just talk about the 800. So there is a lot of opportunity, and this is early days. You don’t have to make massive assumptions. I mean, if you look out five plus years, not a stretch to think they could have 50% more subscribers. Again, five plus years, not a stretch to think the ultimate profitability of this business doesn’t look dissimilar from what cable networks look like. Now, you could argue with global scale, it might even be more profitable than the local scale model of the historic cable networks. But if it’s anywhere close to that, it looks like there is very significant upside here.

Clay Finck (24:49):

When I was looking into the valuation of Netflix, I was hearing some people talk about how they’re valuing them based on their subscriber base, which I found odd. As value investors, we’ve always thought about, “Okay. What’s the present value of the future free cash flows?” They’re not mentioning that aspect, but they’re valuing it on a subscriber basis. Is that an appropriate approach for Netflix?

Tony Coniaris (25:12):

Well, I think you’re hitting on something that’s really important, and that is focusing on subscribers alone is not right. So the answer is yes and no. The yes part of the answer is as an investor, particularly a value investor, you should be using anything that’s helpful. Right? The subscriber numbers are helpful, and if other like businesses are sold, and it’s for a certain multiple of subscribers, and the economics look somewhat similar, maybe that’s a good tool to be looking at as a check, right, but not the be-all-end-all, and so that’s the yes component. It’s a good check. You should use everything that’s helpful, and you should be very curious enough to look at anything and everything that might matter.

Tony Coniaris (25:51):

The no is if you look at it alone. You should be looking at everything and tying non-financial metrics like subscribers back to economics and free cash flow ultimately, and that’s what we do. So while we look at the subscriber numbers, and that’s a nice shorthand way to think about the valuation or check the valuation, ultimately, what we’re do is discounting future cash flows, and we have to make sure that those subscriber valuations tie back to that. So yes and no.

Clay Finck (26:17):

Yeah. That makes sense to take a look at both, and look at the competitors, and how they’re valued, and how the market is looking at it. I’m curious how much is a US subscriber worth relative to some of the other markets, say Europe, Latin America, Asia?

Tony Coniaris (26:33):

That’s hard to say. The right question really is, what are those likely to become, right? It’s going to be tied to something like the earning potential of those citizens in those countries and their potential to spend on and willingness to spend on content-based on historical patterns and their income levels. So that’s what’s really going to drive it because of the different… I would call them vintages of growth. So they’ve entered UK before. They entered some farther Eastern European countries. So there’s just different vintages of growth opportunity here, and some countries are farther along and others aren’t.

Tony Coniaris (27:06):

So the ones that aren’t as far along might actually have as much upside as… because of the number of people or the amount of income, whatever, might have as much collective upside or more as Germany, but India is much likely to be more valuable 20 years from now than Germany is just because the sheer scale, the people and the growth of the incomes. While the per subscriber value may be lower, the aggregate value to Netflix could be higher. So I think that’s the proper way to think about it is that, again, chipping away at this large opportunity. Some markets are farther along than others, and some have collectively more opportunity than others based on the sheer scale of the individuals and the citizens in the country relative to smaller country, big income. You might have big country, little income, but still have a big number.

Clay Finck (27:51):

I heard you mention in one of your previous interviews that your fund had something like a 25% turnover rate, and we’re very much fans of Buffett who has evolved to be an investor that buys a great business and holds it for a very long time. So I’m curious what led you to maybe doing a little bit more buying and selling, and if that enhances returns in your opinion?

Tony Coniaris (28:19):

Well, we stay very disciplined to our buy and sell targets and have that process we’ve had for 45 plus years here doing that, and it’s worked pretty well. We’re big fans of Warren too, and I understand the turnover in his equity portfolio is a little different. One thing to keep in mind that’s driving this difference is Warren has permanent capital. We don’t. Right? We have clients come and go. We have inflows and outflows into mutual funds, and when you have that, you’re going to have to transact in stocks. So there’s just a structural difference between permanent capital and not permanent capital. I do think that’s driving some of it, but the other part is we just have a process that has a discipline to buy and sell targets, and he just has a different permanent capital approach to those businesses than we do.

Clay Finck (29:04):

Yeah, yeah. Your incentives versus Warren’s are different. So it makes sense that your approach is a bit different to account for that. Are you continually evaluating a sell target for Netflix? For example, we saw the stock really run up post-COVID through the end of 2021. Yet, the market realized that the accelerated growth wasn’t going to persist. So the stock has to come back to reality. Are you continually evaluating your sell targets throughout that period?

Tony Coniaris (29:32):

Absolutely. I think one of the most important things investors need to do is just constantly reevaluate based on the data that they’ve been given. Right? The difficult part is, is there enough data to change your mind completely, or is it just iterative impact on the value? That’s the far more common instances where you… but you need to be evaluating that, and that’s what we do here. In the case of Netflix, it’s a case of being, from the beginning, what I call wrong in the right direction. The value growth of Netflix has exceeded what our expectations were when we first made the investment. Same for Google, MasterCard. That’s wrong in the right direction, and then there’s wrong in the wrong direction. You got to be on top of those too, where the fundamentals are deteriorating in a way where you just might be wrong about the people or the quality of the business, and then it’s incumbent on us to move on.

Clay Finck (30:20):

Let’s talk a little bit about a more traditional value pick at least relative to Netflix. That’s Willis Towers Watson, and it’s a new addition to your fund. You mentioned Seth Klarman earlier, and when I was looking at our TIP Finance tool, I saw he was an owner in this company. Could you talk to us about what you found with Willis Towers Watson?

Tony Coniaris (30:41):

Yeah. You’re right. It’s absolutely a more classic Harris Associates, Oakmark investment in that it’s a very company-specific turnaround opportunity. So to understand Willis, I think you’ve got to go backwards a little bit and understand the context of this. So Willis, it’s a leader in the insurance brokerage industry, which is a great industry and corporate advisory, also good in industry, but it had been undermanaged for years. You look at the profitability at an Aon or Marsh, and clearly, they haven’t been running the business as tight as they could have been.

Tony Coniaris (31:11):

Not surprisingly, one of those companies who runs with a much higher margin comes in, sees the opportunity in Aon, and wants to buy Willis. FTC rejected that or at least the remedies were so onerous that they decided not to go forward. So then, deal falls apart, stock falls, and Willis receives a breakup fee, sells its Willis Reinsurance Brokerage business, and is left with a net cash position almost 25% of its market cap and cash on the balance sheet. Not net cash, but total cash, but a slight net cash balance, and change in CEO, activists come in, Elliott, Starboard, and Glenview, and hold management’s feet to the fire.

Tony Coniaris (31:49):

Now, the board has turned over. There’s five new board members out of nine. Four of them were put in place by Elliott, and they’re on… They have formed an operational transformation committee to get those margins where they need to be. Anytime you have an undermanaged company with an insider, become the new CEO instead of an outsider, you worry that they’re not going to get this right or they’re not committed to real change, but we’ve met the CEO. We believe he’s committed to change. There’s been enough change in the C-suite to believe that they’re committed to change. They’ve changed their incentive structures. So that’s going to help incentivize that. Then, again, you can’t underestimate this. The board has an operational transformation committee that’s going to be holding their feet to the fire. If you look at the cost saving opportunity they’ve promised, which is around $300 million, it’s $300 million versus Aon’s synergy target of $800 million and Wisper’s synergy target of over a billion dollars. So that to us.

Tony Coniaris (32:42):

Now, they don’t have all the synergies that Aon had because it wasn’t a merger, but that gives you some sense for how realistic the 300 is, and that’s the way we’re thinking about it. So you’ve got $200 and something dollars stock where if they’d get the margins up and redeploy the cash on the balance sheet the way they’ve promised to, and we believe they will, which has reduced the share count by about 20% over the next two years, you’re looking at a low $200 stock with an earnings level that’s in the low 20s out a few years, and the peers traded 20 or little bit more than 20 times earnings. That’s a pretty good setup.

Clay Finck (33:17):

Yeah. So it’s trading about half the valuation, right?

Tony Coniaris (33:20):

On the fixed forward earnings. The key thing is they need to fix it. That’s what we’re going to be tracking, but that’s the case for any of these, and you want to make sure, again, that there’s a lot of accountability along the way, and that when you’re doing turnaround investing like this, it really helps when you have proxies that can give you some indication of what the profitability could be. We have that here, and we have the incentives and the management’s feet held to the fire. The other thing is this management team was given a playbook during the merger process, and so they don’t have to be geniuses. The geniuses at Aon already gave them the playbook, and so it should be a matter of executing it.

Clay Finck (33:58):

I mean, I’m not super familiar with Willis Towers Watson and Aon, but in my previous career, I actually worked as an actuary, and I had some friends that went on to work there. To my knowledge, they provide a lot of consulting services, and they’re very data-driven businesses. So I’m curious. What is it that Aon is doing that Willis Towers Watson needs to step up their game on?

Tony Coniaris (34:20):

So what Aon has done a great job of, and this has taken a decade, is they’ve digitized what they do. They understand what’s important here. It is, you’re right, exactly, about helping clients wade through complex transactions like insurance, and personnel changes, and things like that. There’s a very strong people component to this, and you want to pay and attract good people, retain good people, but there’s a lot of non-value add, paper shuffling, data shuffling that goes on in the background, real estate. As you digitize, you just have less need for that, and I think what Aon has been ruthless about is getting rid of the non-value add costs and not sacrificing the service to clients. That is just blocking, and tackling, and chipping away at things like, “Do we really need this many offices? Can we outsource this or that? Can we digitize this or that? Can we create an application to do this or that to arm our great people and make them more productive?”

Clay Finck (35:19):

So it really just comes down to the efficiency of the business. I know you guys really like to see share repurchases in the companies you own, and I noticed that Willis Towers Watson hasn’t been buying back shares too aggressively over the years. How do you expect their free cash flows to be deployed going forward?

Tony Coniaris (35:37):

So, you’re right. The business has a lot of free cash flows, and those will be deployed primarily in repurchases, share repurchase going forward. So I would say if you haven’t seen the share decline, get ready because between the breakup fee and the proceeds from the Willis resale, like I said, they have over $4.5 billion of cash on the balance sheet at the end of the year, ’21. It’s our belief they’re going to buy back 20% of the shares over the next couple years. So I would say stay tuned on that. The rear view mirror is not going to look like the windshield.

Clay Finck (36:07):

Well, Tony, thanks a lot for joining me on the podcast. It’s an honor to have the opportunity to chat with you, and I’ve really enjoyed bringing those from your team onto the show and following your work. Where can the audience go to connect with Oakmark?

Tony Coniaris (36:22):

They can go to our website, oakmark.com, and there, from time to time, we put up thought pieces and all of our commentary every quarter there. So if they want to really understand how we think, I would encourage everybody to go back and read through a history of different market environments, different points in time, and see how we think about the world to really understand what we do here at Harris. Clay, thanks for having me. It’s been a real treat.

Clay Finck (36:47):

Thank you, Tony.

Tony Coniaris (36:48):

Take care.

Clay Finck (36:49):

All right. I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app so you can get these episodes delivered automatically. If you’ve been enjoying the podcast, we would really appreciate it if you left us a rating or review on the podcast app you’re on. This will really help us in the search algorithm so others can discover the show as well. If you haven’t already done so, be sure to check out our website, theinvestorspodcast.com. There, you will find all of our episodes, some educational resources, as well as our TIP Finance tool that Robert and I use to manage our own stock portfolios. With that, we’ll see you again next time.

Outro (37:26):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin, and every Saturday, we study billionaires and the financial markets. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.