Last month I had the pleasure of attending the 2016 Pabrai Funds and Dhando Holdings annual meeting in Chicago. It turns out, this was the last Chicago meeting that Mr. Pabrai will be holding for his funds going forward. For those unfamiliar with Mohnish Pabrai, he is the founder and CEO of Pabrai Funds, and currently manages roughly $400mm in capital for individuals and institutions. Mr. Pabrai adheres to a value investment philosophy, whereas he has cloned Warren Buffett’s techniques and has applied them ever since he began investing 1994. Since then, Mr. Pabrai has had phenomenal returns over the years. Recently, however, his funds have under-performed over the last five-year stretch, which in Mohnish’s words, is an anomaly. Mohnish is very bullish on the future of his funds, which we’ll get to later.
The evening consisted of a meet and greet, a presentation by Mohnish, Q&A session, followed by a cocktail hour and a dinner. There was a lot to gain from Mohnish’s insights and views on his investments. Like Warren Buffett, Mohnish doesn’t typically discuss individual stocks within his portfolio at his meetings, but due to his recent five-year under-performance, and significant portions of his portfolio being concentrated on a few investments, he decided to give further explanations into his reasoning behind his two largest investments—Fiat Chrysler Automobiles (FCAU) and his investments in General Motors warrants.
Mohnish’s presentation focused on fund performance and fund outlook, peppered with Fiat Chrysler commercials and topped with his views on the future of Pabrai Fund’s investments. As mentioned, the portfolio is currently valued at ~$400 million, although Mohnish’s believes the intrinsic value is $1 billion+ which will hopefully be reflected within the next 2-3 years (note: current value of Fiat Chrysler and GM warrants within the portfolio are roughly half of the portfolio, or $200 million). This represents 150%+ premium over the current value of its holdings.
The fund’s largest position is in Fiat Chrysler, representing ~28% of the portfolio. The investment has grown to be an outsized position within the portfolio, which he believes to continue to be significantly undervalued.
The auto business is known to be brutally competitive, where customers have a lot of choices. American auto-makers are unionized and the industry requires high capital expenditures. This isn’t the most conducive environment for a prosperous business. Mohnish agrees with all of this points, in fact he even mentioned he “hates the car business”, however, he believes there is still opportunity in the space.
In 2012, Mohnish noticed a few investors who invested in the auto industry. David Einhorn, founder of Greenlight Capital management and (most likely) Ted Weschler, one of Berkshire Hathaway’s head investment managers, invested in General Motors. Knowing them as very thoughtful investors, he decided to drill down into GM and the auto industry, and while doing so, he came upon Fiat Chrysler.
The Company quickly caught his attention, and he mentioned it was one of the most exciting times in his investment career, where he ended up reading up on the Company and the industry for months and often stayed up until the wee hours of the night doing so. The below was discussed during the presentation, but mostly mirrors and quotes his Q2 2016 investor letter where he was able to fully explain his thesis. Mohnish believes the following (Mohnish’s words in italics):
1) Serio Marchionne (CEO of Fiat Chrysler) is a genius
Mohnish admits that he probably would have passed on the Company if it weren’t for Serio Marchionne running the business
“If one had invested ~$1 million in Alusuisse when he became CEO in 1996 and then kept moving those funds as Sergio moved, that $1 million would be worth north of $30 million today. And that includes twelve of those twenty years spent in the lousy car business – with zero prior experience in the auto industry. By 2019, when he intends to hang up his boots and study Theoretical Phyusics (yes, that’s right!), that $1 million will likely have grown to over $100 million.”
“When Marchionne came to Fiat in 2004, it was on life support and almost bankrupt. It had cycled through three chairmen, five CEOs and three heads of Fiat Auto in the previous four years. He nursed it back to health and solid profits so that, in 2009, when the much larger Chrysler was nearly liquidated by the US government and the lights were about to be shut off in Detroit, he was there to pick up the pieces. And he negotiated the purchase with no cash going from Fiat to Chrysler’s owners. If there is a better negotiator than Sergio on the planet, I am not aware of it.”
2) Fiat Chrysler has superior products and a strong brand
When Sergio took over in 2009, there were only 250,000 Jeeps sold in the world, with the majority of them being sold in North America. In 2016, Jeep sales will reach 1.5 million, and is on pace to reach 2 million jeeps in 2018. The Jeep brand is something to be reckoned with, and is a Fiat powerhouse.
“With its World War II legacy and seventy-five-year history, Jeep is an iconic global brand. In China the term people use for SUVs is Jeep. Like Xerox, Fedex or Kleenex. Products like the Wrangler have virtually zero competition, Folks who aspire to own a Wrangler see almost any other SUV inferior. FCS does not break it out, but I am sure FCA nets over $4000 on average per Wrangler. And, on average every Jeep nets them north of $2,500. The Chinese joint venture Jeeps are likely half of that. Let’s say those are $1,000/Jeep. In 2018, the Jeep business alone will likely generate pre-tax earnings of over $4 billion.”
“…RAM has wrestled market share from Ford and GM. Since 2009, RAM’s US market share has doubled from 11% to 22%. Their Canadian performance is even better – going from 14% to 30%!
“RAM’s global volume is slated to be 620,000 units in 2018. They print money on these with average profits of over $5000 per truck or commercial van. In addition, outside NAFTA, the Fiat commercial lineup does another 600,000 units a year.
“The North American light truck market delivers margins that are similar to those of European luxury imports and this oligopolistic business deserves to be valued along the lines of BMW, Audi, etc.”
3) Fiat owns three auto-parts companies that are extremely valuable
Fiat’s auto parts companies, Magenti Marelli, Comau and Teksid, generate over $10 billion in sales. In the past, the parts businesses have had a measly 3% operating margin. Despite these low margins, Fiat has already received offers north of $2.5 billion for these businesses. These margins are slowly inching upward, quarter after quarter. Sergio’s ultimate goal may be to gain more robust margins and subsequently sell the businesses.
“There have been rumors that FCA has received offers for these businesses from private equity firms for $2.7 billion. FCS is said to have rebuffed these offers as too low. Marchionne has hinted that these businesses may eventually be sold. In 2015, Marchionne named Pietro Gorlier as CEO of Marelli. Unlike other auto parts companies, Marelli has had very low margins – less than 3%. Born in Turin, Italy, Pietro is a battle-tested Fiat executive. After Pietro’s arrival, margins have begun an upward trajectory and are now at 3.8%.
“Sergio is an operator. He has no desire to run a 4% operating margin business. I suspect Pietro will work to raise these margins to 5% or more. A Marelli sale in 2-3 years may net the company something north of $4 billion. The entire market cap of FCA is less than $8.5 billion. Marchionne has also wanted to hang on to Marelli for a bit because of Maserati, Alfa Romeo, etc. are leveraging their considerable engineering expertise on some of their upcoming models.”
What’s it all worth?
“To be conservative, let’s ascribe zero value to the Fiat 500, Alfa Romeo and all various other minor brands in the portfolio. Here is the sum of the parts’ pretax cash flows in 2018.
On an after-tax basis this is $7 billion. Sergio’s own guidance is for $5.2 to $6 billion. I believe his numbers are conservative and will be revised upward. By 2018, the company will have over $5 billion in net cash. If they have sold Marelli by then, they may have $9-10 billion in net cash. If they do generate $7 billion ($5.40/share) in cash flow in 201, the market cap will likely be north of $35 billion ($27/share). It is less than $8.5 billion today. A business that generates $5-7 billion in cash flow is not going to change hands at $8 billion…
What if the shares are languishing at a P/E of 4 or less in 2018? FCA can also simply but $2-3 billion every year into share buybacks in 2019 and beyond. The value accretion to the remaining shareholders of such an action would be huge.
Because FCA started its journey with lots of debt and leverage, they have not been able to capture the economics of having a fully captive global financing arm. These captive finance arms, if run prudently, are amazing businesses. By the mid to late 20s, such a captive financing business could be generating $1-2 billion in annual free cash flows at FCA. These cash flows aren’t cyclical deserve a double digit multiple. Alfa Romeo is also a next decade story. Alfa could be worth billions by 2025. We are likely to either fully exit or sell most of our stake in 2-3 years. There is a good chance that even at $27/share we may have sold too early and left a lot of money on the table.”
The Potential Headwinds and The Changing Car Industry
The market has been worried about Fiat’s place in the “future” of cars i.e. electric and driverless cars. Mohnish’s views are extensive on the matter, but can be summed up fairly quickly.
1. Electric cars
“Tesla makes awesome cars, but it is a negative operating margin business and requires extremely high capex. Fiat does have an electric car and will also have a plug-in hybrid as well. Once (if ever) Tesla is able to make money on a $35,000 Model 3, he will have a close of it (with Italian flair and styling) in the market within a year. If Elon is successful with Tesla, it will not be a threat for a long time. FCA makes money on Jeeps, RAMS and minivans, and Tesla has no products that compete head to head with any of the main FCA “cash gushers”. Electric cars won’t ruin the FCA investment thesis.”
2. Driverless Cars
Autonomous driving is not within Mohnish’ investment horizon therefore the discussion is almost comical. If the world was 100% driverless tomorrow, what would it look like? A family may need less cars, which would cut down a fleet of cars… but at the same time the amount of total miles traveled by the US car fleet would skyrocket because of the following.
- If you summon a car to come get you to take you to work, these are incremental miles that otherwise wouldn’t be driven.
- Cost/mile of traveling will plummet.
- Driverless cars mean more frequent road trips or one may live further away and be able to afford in better dwellings
- More driving means less car life, meaning sales would rise significantly.
“The bottom line is that the total number of automobiles sold globally may rise significantly in a driverless world. It won’t happen for 15+ years. Second it likely provides tailwinds when it happens.”
3. Automobile sales have peaked (or the market believes so)
“The US car fleet has grown has grown in lock-step with the US population over time. The bottom line is as long as the US and Europe muddle along, car sales aren’t going to fall off a cliff. If we go into a recession, volumes will drop. How much they drop is function of how bad things get.
4. Recalls and product liability
“The auto manufacturers aren’t manufacturers anymore (that is why labor costs are so low as a % of sales). They are assemblers. If there were to be a large liability stemming from a vehicle defect, there is a decent chance FCA and GM could pass much of it along to the part supplier…I am hopeful that any issues that arise are a small fraction of cash flows.”
5. Gas and commodity prices
The primary risk here is what if commodity prices rise? What happens when interest rates rise? At some point both are bound to happen. There a few things to remember.
First – Yes, low gas prices have been a boon to the American people’s love of SUVs and trucks. Don’t forget that there have been great strides in fuel economy. Higher gas prices will cause some softness in SUV sales, however this is somewhat mitigated by fuel economy. Secondly, The significance of the change in the US oil reserves is astounding. We now know that our oil reserves exceed those of Saudi Arabia and Russia. This is a huge positive for the United States – in addition to mankind. Because of this, the odds of oil prices averaging $60/barrel over the next ten years is much higher than the reverse. If oil prices to rise, auto sales will be partially offset by fuel economy.
“We will see reduced profits when commodity prices rise (again with a lage). Similar, rising interest rates are a headwind for car sales. However, it is likely that both will happen when the economy is creating a headwind for car sales. However, it is likely that both will happen when the economy is creating more jobs and higher-paying jobs. More prosperity means more car sales. Anything can happen, but it is hard to see commodity prices and interest rates skyrocketing before 2020 while job growth stagnates.”
Question and Answer Session
The Q&A session was shorter than those I’ve read of in the past considering the length and number of questions, largely due to the significant emphasis Mohnish put on his presentation and discussing their large positions at length. Below is a summary of the Q&A session.
For your investment in Fiat Chrysler, what is your downside case?
It’s difficult to see a downside case to Fiat. Mohnish explained the primary assumptions underlying the strong demand for several of Fiat’s key brands. You can refer to the latest Fiat investor presentations for the assumptions on unit volumes through 2018. There has been a secular shift from cars to SUV’s, so the big question is what can derail that trend that Fiat is taking advantage of? The answer is very little. Gas prices are highly unlikely to derail this secular trend. It is very unlikely for sustained $70 per barrel oil in the near-term, and increased fuel efficiency standards are continuing to push the mark toward larger vehicles.
Ford is investing heavily into technology and autonomous vehicles, what are your thoughts on their initiative?
Sergio’s view is that GM and Ford are wasting money. The whole idea of autonomous vehicles will be able to be replicated and serviced by the current suppliers, who are also working toward similar goals. Furthermore, disruption of transportation won’t be until level 5 driving, which won’t be for 15-20 years (and maybe even more). It’s much better use of Sergio’s time and the Company’s time to focus on the current 5-year plan.
Given that you are discussion individual investments such as Fiat Chrysler and GM this year, are you willing to discuss Aercap Holdings?
Save this one for another year.
Apple was an investment that Berkshire entered in this, why won’t Pabrai Fund’s invest in Apple?
This is largely due to sizing considerations. The Apple investment was most likely made by Todd Combs, in Mohnish’s opinion, because it fits his style and is in line with some of his other investments. Since Todd and Tedd, the two investment managers for Berkshire Hathaway, manage $10 billion each, they are seeking investments in size of roughly $1 billion. This size consideration extremely diminishes the amount of investment opportunities out there for Berkshire, (and you can imagine what it’s like for Warren with four times the amount that Todd and Tedd have). If Todd and Tedd are investing $1 billion into each investment and purchasing ~2.5% of a business, this assumes they are targeting businesses that are ~$40 billion in market capitalization.
Earlier in the meeting, you mentioned you are finding that many of the companies you are looking at are either fairly valued or over-valued. Is it a good time to begin to transition and hold cash?
The fund’s sold half of Ferrari, which looks expensive where it is currently trading at ~20x earnings. Pabrai Fund’s isn’t holding the current market and currently is invested in what he calla “quirky” businesses. Mohnish is thinking about selling certain holdings to boost cash.
Is Dhando Holdings going to be directly buying any new businesses?
Mohnish has looked at potential investment opportunities, but in the current private markets, multiples are fairly healthy. There is a higher ROI in common equities and other areas. However, Pabrai funds will be opportunistic if the a great private business at the right price comes by.
What is your vision for the Dhando Junoon ETF business?
The ETF business is a great business with wonderful economics once you are able to scale. There is a commandment from Warren Buffett that says if you deliver above market returns, investors will swim to you in shark infested waters. The Dhando Junoon ETF is based on this premise. The Dhando Junoon ETF is set out to beat the market by a few percentages per year. Over time, investors will recognize this and flock to the ETF. The business will begin to scale once billions have been invested.