In contradistinction to the typical company, many owner-operator companies-those whose manager is also the primary owner and for whom that capital represents a major or the greater portion of their wealth-have been investing aggressively during this period rather than accumulating cash. Historically, owner-operators have a statistical likelihood of producing a far more favorable result than the average company. And it's hypothesized, but could never be proven, that those favorable results are a function of the incentive of management having most of its wealth embedded in the company, so that the only pathway to increase that wealth is really the success of the enterprise. It is a little known fact, even within Horizon Kinetics, that Horizon Research once published something known as the Intangible Asset Report, which was a regular compendium of such individuals and their companies.
In recent weeks and months, some of the following owner-operator transactions have been observed; consider, in each case, how cyclical or financially risky these businesses appear to be:
- Wilbur Ross recently purchased in excess of 1.3 million shares of Assured Guaranty which, among other activities, provides mortgage guaranty insurance to institutional lenders. That represents a commitment of about $16 million. He already owned 16 million shares, or 8.7 percent of the company. This latest purchase was at approximately 52 percent of book value.
- In July 2011, Wilbur Ross and Fairfax Financial, the property-casualty insurer ably led by owner-operator V. Prem Watsa (13.2 percent book value/share growth since 2001), each agreed to invest 300 million in the Bank of Ireland. Each will own 9.9 percent.
- Google, under the leadership of Larry Page and Sergey Brin, recently agreed to buy Motorola Mobility for $12.5 billion, presumably for its patent portfolio. It also recently announced it is acquiring Zagat, the restaurant guide, for $125 million.
- Carl Icahn recently purchased another 3 percent of the auto parts maker Federal Mogul. He had already owned about 75 percent. He had made those purchases at, more or less, book value.
- Charlie Ergen's DISH Network, some months ago bought Blockbuster Video out of bankruptcy for $320 million. And some months prior to that, through his other company, known as EchoStar, he paid $2 billion for Hughes Communications, a satellite manufacturer, presumably because in two or three years the United States will exhaust its available cellular spectrum and have to rely upon the bandwidth granted to satellite providers. There are a handful of individuals - owner-operators, not agent-operators - that have been purchasing the available satellite spectrum over the last several years.
- BGC Partners, formerly known as Cantor Fitzgerald, the bond dealer, led by Howard Lutnick, recently bought Newmark Realty, a real estate broker, real estate being about as depressed as real estate has ever been.
- Joseph Steinberg and Ian Cumming of Leucadia National recently acquired nearly 27 percent of Mueller Industries. Mueller Industries makes pipes and fittings for the housing and large-scale construction markets, which are clearly depressed. As of the most recent 13D filing, Leucadia owned 26.7 percent of the company.
- In late September 2011, the board of Berkshire Hathaway, a company that for 40 years has not repurchased any shares, announced that it would repurchase potentially billions of dollars of shares at prices up to 1.1x book value. The shares are the same price they were five years ago, although book value is about 45 percent higher.
What can be said about the many such investments being undertaken by individuals who have demonstrated dramatic serial success over decades of managing their companies? They are expending, while the average company is husbanding, cash. They are buying cyclical or risky assets that others are selling. They are doing so with their own balance sheet capital-that is, they are not issuing shares to do so. They have not, surely, all become foolhardy simultaneously.
The Owner-Operators as Harbingers of a Bubble Reversal
They also, as a class, trade at remarkable, perhaps record discounts: near or below book value, or deeply below net asset value, or near or at single-digit earnings multiples. Over the past few years, they have sold at ever cheaper prices, even as their financial progress continues.
This circumstance feels much like our experience in the 1999-2000 bubble period, when the bluest of blue-chip holdings were - literally, as they now say - discarded in favor of technology, internet and telecommunications stocks. Here is the current version of that phenomenon. In the new world of portfolio variability control and asset allocation via indexation, equity investing is increasingly done via batches of stocks rather than individual stock selection. The goal, in part, is to avoid idiosyncratic security risk. The associated flow of funds is, accordingly, into stocks that are constituents of popular indexes and ETFs. This is evidenced by the percentage of the $4 trillion of domestic equity mutual fund assets that is invested in equity index funds: while virtually flat between 2004 and 2007, this measure rose by one-quarter, from 11.5 percent to 14.5 percent, between 2007 and 2010. These index funds received new assets, on a net basis, even in 2008 and 2009, when the equity markets were in decline.
As part of this trend and in order to accommodate larger fund flows, the various index providers began to adopt float-adjusted market capitalization methodologies several years ago. Under this system, inclusion or exclusion from an index is not based on the total stock market value of a company but rather, on the market value after excluding shares held by insiders. Accordingly, many owner-operator companies find themselves increasingly outside of the flow of funds. Other owner-operators that have sufficient float, yet which are multi-industry or portfolio-type owner-operators, such as Leucadia National or Brookfield Asset Management, have found themselves excluded due to the necessity, in the index-driven, ETF mode of investing, of conforming to a clearly defined industry sector. Paradoxically, as many of these owner-operator companies repurchase shares, their float decreases, which means that their index weights are reduced, if they are in an index, which in turn requires share sales by any index-based holders. Contrarily, companies that issue more shares may well increase their index weighting.