Wed, 20 Jun 2012
Ariel's John Rogers discusses recent opportunity in Madison Square Garden and International Speedway, as well as the firm's analytical adjustments in the wake of the financial crisis.
Christopher Davis: I'm Christopher Davis, a senior mutual fund analyst at Morningstar, and I'm here at the Morningstar Investment Conference with John Rogers. He's the founder of Ariel Investments and also is the veteran manager of the Ariel and Ariel Appreciation funds.
He employs a relatively concentrated, value-oriented strategy and has delivered fine long-term records at both funds, and I'm glad to have you here today, John.
John Rogers: Glad to be back.
Davis: Well, I was looking at your website the other day, and you have an article about sports, and you reference that the Dodgers recently went for $2 billion or was that $2 billion?
Davis: And so it's big business and it's something that you as a value investor have been able to tap into. Obviously as a public fund, you can't buy sports teams, but how are you benefiting from the sports theme?
Rogers: Well, it really does fit within in our circle of competence. I joked that I was a vendor at Wrigley Field and Sox Park for six years, and so got to know a lot about sports through that, and then I got to play basketball at Princeton, and got to be in a lot of great arenas. And so sports has been a passion of mine for a long time.
But today there have been so many bargains that have crept into the sports world. First it was Madison Square Garden for us. Back when the NBA lockout was going strong, people got very fearful and they thought that the whole season would be lost and the stock price drifted lower; people got very discouraged. We came to the conclusion that eventually someday that strike would end or the lockout would end. The Knicks would be back playing in the Garden again, and all the other teams that will be there, the Rangers, the Liberty as well as the concerts and things like that, would fill that arena on a regular basis.
The Garden, they spent over $900 million to renovate it, and they got enormous pricing power. So it fit that whole Warren Buffett message around how big is the moat. When they raised prices, people kept coming, people wanted their season tickets, people wanted their SkyBoxes. There really isn't any other "across the street" from Madison Square Garden, the world's greatest arena.
And then finally we got a break when Jeremy Lin got to be such a sensation. He was right at the midst of them renegotiating their television contract with the local cable networks, and they were able to leverage that to get the kind of pricing that was so valuable to the overall value of Madison Square Garden.
Davis: I think you are the first manager I've talked to that's benefited directly from Linsanity?
Roger: It's true. It's absolutely amazing. We went to visit right before they signed that contract, got a chance to see Jeremy Lin play and walk through the Garden, and it really was a very direct benefit that he did so well for that short period of time.
The other sports-related company also has a television aspect to it. We own International Speedway--that's closely affiliated with NASCAR. And similarly they have these huge arenas. I went to visit the arena in Daytona, and I'm going to the one in Joliet soon, and they have Talladega, and they have so many venues around the country. They are these huge places; some of them seat well over 100,000 fans, and those are very hard to replicate, very hard to duplicate. To replicate the relationship with NASCAR is, we think, next to impossible. And people are very fearful the next contract won't go well. But we find that the ratings have been holding up well with NASCAR, and we think it will be a surprise on the upside, the kind of contract they are able to renegotiate in the next year or so. And when you think about it, live sports are so valuable to the networks, even in this TiVo age. People don't want a TiVo their basketball game or their race that's going on. They want to watch it live and not miss a moment, and so that's why these contracts are so valuable and why they keep going up in price and surprising people.
Davis: Another topic that you also discuss on your website is the euro crisis, and it seems to be the opinion of your firm that this is kind of a Europe issue, isn't likely to wash up on the shores of the U.S.
Is that still something that you are thinking about, and how do these larger, bigger-picture macro ideas play into your strategy?
Rogers: On the idea of the big global macro issues, not to keep coming back to Warren Buffett, but we do believe that he's right when says that, when you look at the history of this country and our capitalist democracy, we find a way to solve whatever the macro problems happen to be. We've been through great depressions, we've been through the '73-'74 recession, we've been through oil embargoes, we've seen oil spiking, we've seen all kinds of crises that have hit the country and have affected the macro world. But inevitably we solve our problems, we have the best system ever invented, and things get back on track. So I'll start with that to say, we try not to let the macro short-term events, and the emotionalism of them, change our long-term impact or the long-term research that we do on the individual companies that we believe in. We are going to be leaning forward with the sense that things will get better, problems will be solved, our country is very resilient, and again don't get caught up with those short-term emotional moments.
Now when it comes to Europe specifically, I was talking to someone the other day, and I'm not sure exactly the analogy, but he said that every several months China creates a new Greece in how rapidly it's growing and how giant it is. And Greece is really a relatively very tiny country with a relatively small economy, and I think the press has been able to make this a huge event, and how catastrophic it would be if Greece fails and gets pushed out of the euro and the contagion and all that stuff, it sounds sexy and scary, but in reality, Greece has failed numerous times in the last 100 years, and it is a small country. And I think we are really, again, making more of it than we should. And there's less of an understanding of how the Greek leadership may or may not do the right thing, but the European leadership now is totally focused on creating the right answers in case it does default. And I do think they'll be able to pour lots of money to the euro countries to stay in euro, and that they will come together and do the right things, so that there won't be contagion. So, I'm quite sanguine when it comes to the future of Europe, and I think people are just too worried about it. This, too, will pass, and as Warren says, again, 10 years from now, Europeans will be living better than they are today.
Davis: Well, let's hope so. Now you mentioned just this idea of ignoring noise, ignoring short-term volatility, and when you look at the performance of your funds in the mid-2000s, the funds were much more volatile than they had been historically. Can you talk a little bit about that, but more importantly, what you've done about it since then, and sort of your advice for investors, because no matter what happens in Europe or the U.S. or throughout the world, it does seem like volatility is here to stay for at least the near future.
Rogers: The volatile period for us has really been mostly the last, I guess, it's five years or so. '08 and early '09 clearly were the most volatile period in the history of our firm, our whole 29 years in business. And what made it tough on customers was we had more downside volatility than we had ever experienced, and we underperformed to the downside, which was very unusual for us.
So to your question of what we've done to improve on that, we've thought that we had a great margin of safety in the way that we do our research, and the balance sheet analysis we thought was rock-solid, but we learned the hard way through '08 and early '09 that we needed to ratchet up the quality of our balance sheet analysis, and add more layers of conservatism to it.
And so Charlie Bobrinskoy, our vice chairman, has led us through a process to come up with our own proprietary debt ratings. And we look at a myriad of extra layers of analysis to help us make sure that we won't have that kind of downside volatility often caused by weak balance sheets. And as you know, a lot of companies just did not factor in the '08-'09 crisis, and so therefore they weren't strong enough financially to handle it. Companies made acquisitions at the wrong time, bought back stock at the wrong time, didn't use their cash as conservatively as they should have. So that's a major improvement that we've made in terms of our own proprietary debt ratings.
The other thing we've done, which is consistent with what we've learned from working with Morningstar, is we use a lot of your work in determining the moat ratings of our companies, because our portfolios have always done well relative to peers in the percentage of our companies that have moats. But we decided we wanted to make sure we had our own analysis of the moats of each and every one of our companies, and to determine whether the moats were growing or strengthening or weakening or staying the same. And we felt that was another added layer of conservatism to our approach to make sure that we could articulate in our weekly research meetings the strength of the moat in each and every one of our companies.
Davis: I know, since the crisis, since early 2009, the funds have outperformed quite substantially, but have you also found that in the moments of volatility, that these risk measures have proven effective.
Rogers: Well, you know, it's really fascinating to me what's happened in this great recovery. You're right, we have had a terrific 3 1/2 year run since March of 2009; at different times we were showing top-of-the-charts performance over that recovery, and some of it was because of the improvements in our processes and the strength of our team being battle-tested through that period.
But the other thing we've learned is that our portfolios might continue to be more volatile because we're finding the best bargains in the higher-beta stocks, and it's interesting to me that what's happened in this risk-aversion world--I was just talking to [Morningstar CEO] Joe Mansueto about it, about how people have gotten so fearful today--and so what happens is, not only are they putting money into cash and fixed income, but they're buying the safest equities they can find, the steady-Eddies. So companies like Clorox that we owned forever, over 20 years in the firm, it got to 17-18 times earnings, even though its growth rate is going to be mid-single digits, but everyone wanted to be in those kind of safe businesses.
We sold a company like Clorox and put the money into companies where they had a higher beta, but in effect, those companies are going to grow 12%, 14%, 15% a year, and they were selling at multiples closer to single digits, not 20. And so great companies like CB Richard Ellis and Jones Lang LaSalle in real estate services, consumer companies like Royal Caribbean, the cruise line company, selling at 10 times earnings. A company like Gannett at 5 times earnings.
And you look at a lot of these companies, people perceive that they are still the same risky company they were three years ago, and they think they'll perform the same way in the next bear market as they did the last time, but people are not doing the homework to find out these companies have diversified their products, diversified geographically, strengthened their balance sheets. So we think we're getting the best of both worlds. Companies that are cheaper, better companies, growing faster, but selling at real bargains because of this race toward risk aversion.
Davis: John, I really appreciate you joining us here at the Morningstar Conference. I'm Christopher Davis. Thank you for watching.