Andrea Gentilini of Novus spoke last year with Soo Chuen Tan, the founder and president of Discerene Group LP, an investment firm he founded in 2010. Very good listen, the link to the full interview is here for ease of reference:

https://www.novus.com/podcast/soo-chuen-tan-discerene-value-and-values

Below are a few things I found interesting – these notes are paraphrased and for personal reference only, so any mistakes in transcription are my own.

On his fund’s structure – more akin to a PE structure, where their investors make capital commitments to them. Instead of funding their entire investment up front, his team can call this capital over time as they find compelling investments. This structure evolved from his observation that investment firms tend to get the most capital inflows after periods of outsized performance, when generating prospective returns might be the most challenging. Their structure allows them to sit on capital commitments without drawing them down. This allows them to maximize the dollar weighted returns and not just the time weighted returns. To use a spring coiling analogy, it allows them to deploy more capital when coiling the spring of prospective returns and not forcing themselves to invest just after the spring is uncoiled. The key, however, is having the right partners. All of their investors funded when they have made capital calls, most recently during the market dislocation of Mar/Apr 2020. That response requires good liquidity planning, strong investment discipline and tremendous trust.

Example of a successful investment – Protelindo, which is the leading independent cell tower company in Indonesia. When they were buying the stock in the summer of 2018, shares were trading at 11x earnings, 7x EV/EBITDA, 5% dividend yield. Because operating costs were so low once the towers were built, Protelindo enjoyed through cycle operating margins of above 60%. Net debt was also modest at 2x EBITDA. The company could take on a decent leverage because customers are locked into multi-year contracts (e.g. US peers have net debt of up to 7x EV/EBITDA). The Indonesian tower industry also had a longer growth window; monthly mobile data consumption per connection was ~1/3 of neighboring Malaysia and Thailand. Protelindo’s tower base had grown at 18% annualized over the previous decade. Wide-moat as the tower business tends to be a natural monopoly. Because the company generated so much cash, they were able to fund most of their growth internally. And despite all its capex needs, the company had also returned about half of its net income to shareholders as dividends since 2017.

How did they manage to buy it so cheaply? 1) The company was countercultural in the way it managed its balance sheet. By refusing to take on a lot of debt to finance even higher growth rates, it suffered vs. peers who were more aggressively following the lead of LBO companies in running their businesses with larger debt loads. Through the looking glass of modern monetary policy, investors apparently seemed to view debt as an asset and cash as a liability. 2) Growth was slowing, due to the law of large numbers (base of towers was getting larger in proportion to new tower additions). At the same time, old contracts that were overly generous to Protelindo were rolling off. In a growth obsessed investing environment, this was perceived negatively by investors. 3) Based in Indonesia, its stock traded down when emerging markets sold off more broadly in the summer of 2018. 4) Not particularly liquid; when multiple investors were trying to sell, they found there were insufficient buyers on the other side. When they were accumulating shares, a seller inquired if they were willing to buy a block at a discount. Seller offered 3% discount. They said no, needed 15% discount, countered with 5%, 10% etc. The seller eventually agreed to 15%.

One of their least successful (fully exited) investments – Ellaktor Group, a Greek construction and infrastructure conglomerate they invested in during the Greek sovereign debt crisis. The heart of their thesis was that the consolidated financials, which showed little profitability and significant debt, understated the true economics of the group. Most of Ellaktor’s assets were financed at the project level with debt that was non-recourse to the holding company, but all of that debt was consolidated on their balance sheet because the company controlled each business. Some of these assets also had significant non-cash accounting amortization, such that reported earnings were significantly less than free cash flow.

Ellaktor also had several hidden assets, in particular a ~25% stake in a low-cost, non-producing gold mine, the majority of which was held through European Goldfields, a publicly listed Canadian company. Because the mine was not yet operational, it contributed nothing to earnings but they believed the low cost gold reserves could be monetized. In early 2012, El Dorado acquired European Goldfields at an implied valuation of EUR 400m for Ellaktor’s combined stake in the asset. Ellaktor also owned a controlling stake in the largest toll road (Attiki Odos) in Athens, which generated >EUR 50m in FCF annually for the group, but less than half of this in reported earnings due to significant non-cash amortization. The toll road business also had a significant net cash position, which was unusual for that type of asset. Ellaktor’s claim on the net cash balance alone was more than EUR 100m and, more importantly, Attiki Odos did not guarantee the debt obligations of other group companies. By adding up the valuable assets, marking the other assets at 0 and subtracting holding company debt, they estimated that the stock was trading at a large discount to its intrinsic value.

What happened? As it turned out, the controlling shareholders of Ellaktor were not willing to exit from their money-losing businesses. In 2012/13, as they continued to burn cash on civil works and other projects, partly in exchange for IOUs from the Greek government, it began selling down its El Dorado stock and reinvesting in its construction and other businesses. The company’s capital allocation decisions caused them concern and led to them exiting their investment. In hindsight, they should have foreseen that Ellaktor would continue working with the Greek government even though they were not paid and even without legal obligation to do so. After all, Ellaktor had accumulated its major assets because of its good relationship with various Greek governments. Stopping work on public civil works projects for non-payment would have caused major egg on face for the government and consequential job losses in an already battered economy. The broader lesson here was about investing with companies operating in a thick business culture where a tapestry of unwritten social contracts may significantly affect businesses and investment outcomes.

Thick vs. thin cultures – he cites the work of Mishler and Pollack and explains how, as an investor, bridging the gap between thick and thin cultures may not be easy. Capital allocation decisions that may seem irrational when viewed through a thin culture lens (e.g. the US), may seem perfectly reasonable and even necessary when viewed through the lens of a thicker business culture (e.g. Europe). Likewise, a thin culture view of ownership as primarily an economic and legal concept is sometimes at odds with a thick culture conception of ownership, which might contain more social and historical meaning. For example, it may not be obvious to a management team operating in a thick culture that an investor who bought 2% of the stock actually owns 2% of the company, especially if that stake was acquired only recently and might be disposed of soon.