Shannon Zimmerman: You and Richie [Freeman of Legg Mason ClearBridge Aggressive Growth Fund] are also high-conviction investors, not only in terms of being willing to have sizable sector allocations, but in terms of individual names as well. At the end of March, the biggest name in the portfolio was Anadarko Petroleum, I think. You have a pretty good exposure to energy, and that's the largest name there with about an 8% position size. What's attractive about that company, which is down on a year-to-date basis, but over the last 12 months, has done quite well?
Evan Bauman: It's their global presence, and rather than trying to predict the next $5 or $10 move in the prices of the commodities, which has become commonplace, we've owned Anadarko for over eight years now. The beauty of Anadarko is some of their exploration successes around the world. So, we're really focused.
While they were certainly in the news last year around the Gulf of Mexico and the spill there, where they were a 25% investor, our focus on Anadarko has been their properties in Northwest Africa, places like Sierra Leone, places like the Ivory Coast, as well as Ghana, as well as their properties where they've drilled in Brazil and China. This is where we believe their real successes will come from.
Zimmerman: I know that you focus again on the company's operating bottom-up fundamentals, but how much time do you spend with a company like Anadarko? So they are in Ivory Coast; there's political risk there. Or with a Deepwater Horizon, there's still some liability concerns around that. How much time do you and Richie spend discussing those kinds of matters?
Bauman: A lot, and we have 21 analysts at ClearBridge, very capable energy analyst who does a lot of the primary research. In other words, he'll fly over to the Middle East and view the company's properties there. But I think it's very important. It's also important to have globally diverse operations, and so Anadarko is a major player in the shales here in North America as well as the Gulf of Mexico, and then again they have properties all over the world, including places like China.
So, I don't think you want to focus just on one particular area with a lot of political risk; I think you want to diversify. And one of the lessons learned from the goings-on in the Middle East, Libya, Egypt as well, is how important it is to diversify your asset base and that's one of the things they've done brilliantly over the last few years.
Zimmerman: So, looking at it from a valuation perspective, Anadarko doesn't look especially cheap relative to its own history. Could you talk a little bit about the valuation case for Anadarko as it stands right now, but then also more broadly, how you and Richie approach valuation?
Bauman: On a company like Anadarko, we still think they're attractively valued based on their proved reserves. I don't believe they're getting the full value for some of their exploration projects where they've had enormous successes, including that multiple 100-mile stretch on the Northwest African coast. So it's really a combination of factors, rather than just traditional earnings or cash flow per share.
In terms of generally how we look at a company, it really depends on the particular industry that the company is in. Typically we try to make sure we don't overpay for growth. Most of our companies are either profitable or really on the verge of becoming profitable, in the case of some of the emerging biotechs that we own like Vertex Pharmaceuticals, but we want to make sure, again, even though the company is growing significantly, we don't overpay for that growth. We look at P/Es, we look at P/E-to-growth rates, and those are the most important things that we tend to look for.
We also look for companies that have cash flows and significant repetitive cash flows, because it gives the companies the flexibility in difficult times to continue to invest.
Zimmerman: Just sticking with Anadarko, again, because it's your largest position, relatively lumpy cash flows, because it's a commodity-based business. How do you account for that? How do you normalize cash flow?
Bauman: We look at their value of their cash flows, which are approximately $5 billion this year alone. Their capex ratios are actually coming down. And we try to look in the case of Anadarko at what their properties might be worth to another larger company. There's been significant consolidation in the energy space. We expect that to continue. And when we look at the value of Anadarko on a net asset value basis, we think it's well north of where the stock trades for.
Zimmerman: So you're doing some intangible asset valuation work as well?
Bauman: That's correct.
Zimmerman: All right, interesting.
Bauman: And that's, as I said, we've had a number of deals in the portfolio, and I think that's especially important in the health-care and the energy spaces, where consolidation is occurring quite rapidly.