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Akre: The Three-Legged Stool of Investing

Ryan Leggio

Ryan Leggio: Hi. I'm Ryan Leggio. I'm a mutual fund analyst at Morningstar. And with me today is Chuck Akre, the current manager of Akre Focus Fund and the former manager of FBR Focus. Chuck, thanks so much for joining us.

Chuck Akre: Thanks, Ryan.

Leggio: I thought we'd talk a little bit about your new fund and what it was like starting a new fund.

Akre: Well, it was a great experience, and we were able to put together a prospectus and file it with the SEC in a short period of time, three weeks, and had a very quick turnaround from the SEC in August. It was approved by the end of August. I think we were in and out in 34 days.

And we've had a great deal of help by choosing to go with a multi-series trust that, in this case, is part of US Bancorp. And they were very helpful to us in doing all of the nuts and bolts as it relates to putting a mutual fund business in place. In the past, we had simply managed the assets of the FBR Focus fund.

Leggio: And I know you're going to be using the identical strategy that you used at your previous fund here. Can you talk a little bit about your strategy and how you go about finding great businesses?

Akre: Sure. We are both growth and value managers and think that the value in a given situation, growth is an integral part of that. And so we use a construct of the three-legged stool. We actually have a little 19th century three-legged milk stool in our office that just is out there as a visual prop for us.

The first leg has to do with the quality of the business enterprise, and we're looking for businesses that earn high returns in the owner's capital. We spent a lot of time trying to focus on what's causing that better-than-average result, return on capital, to occur, and is it getting better or worse.

The second leg of the stool goes to the issue of the people who manage the business. And not only are they terrific managers, but are they honest and do they have high integrity? Do they see that what's happening at the company level is happening identically at the per share level?

And then lastly, the third leg is the issue of reinvestment. We call it sometimes the glue that holds these together. That is, is there an opportunity that exists because of the skill of the manager, the nature of the business to reinvest what we presume is excess cash. To reinvest that in a way to continue to earn these above-average rates of return. And then to that, we apply our valuation overlay, which is our quantitative way of saying we're just not willing to pay very much for it.

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Leggio: Sure. And we're talking right now, in the middle of December, and you've disclosed five portfolio holdings. One holding, which we have talked a lot about, which is a carryover from your previous fund, is American Tower. Can you talk a little bit about what makes that particular company so attractive and why it has such a wide economic moat?

Akre: Surely. American Tower, the majority of towers in this country are owned by the wireless carriers themselves. But there are three major independent tower companies: American Tower, Crown Castle, and SBA. American Tower has, by far and away, the strongest balance sheet in the group. And it's our judgment that maybe they are the best. That's how we have chosen to look at it.

The demand for their service is created altogether away from them. That is the growth in wireless service, which is a worldwide phenomenon. And that growth has been not only an issue of convenience, but an issue of changes in use, from voice to data to video to now even HD. And each of those generations -- first G, second G, third G -- causes the demand for wireless services to increase.

So the external demand for the use of the service is great, and it doesn't cost American Tower a nickel to produce that demand, number one. Number two, their business then is really a vertical real estate business: more towers, more tenants per tower, more rent per tenant.

And then as the demand going from 2G to 3G increases, that requires both a denser antenna network, as well as more complicated antennas. And each one of those is a growth in economic opportunity for American Tower.

When American Tower or any of the other tower companies gets a tenant that becomes incremental -- and I don't know what that number is, but let's call it two tenants per tower -- the incremental fraction of a tenant comes with margins that might be as high as 90%.

So it's a terrific business. The assets have a long life, a life well in excess of the depreciation schedules. And in American Tower's case, a great deal of the cash is sheltered by depreciation. So we shareholders are getting a buildup in economic value that's much greater than fully-taxed gap earnings.

And so we have, really, a compounding machine, and valuation today is sort of 17, 18 times free cash flow of 2010, a reasonable valuation from our perspective for a business that has a long runway of growth and opportunity ahead of them.

In addition to their domestic business, they have a tower portfolio in Mexico, a tower portfolio in Brazil, and more recently, a tower portfolio in India, all of them places with growing economies and friendly environments in which to operate business outside the United States.

So I actually think that it may be the best business model we have in our portfolios. It's a terrific business.

Leggio: So, great business model. You talked a little bit about valuation, and I know that's really important for you, because your goal is mid-teens type returns for not only the companies, but for...

Akre: In our portfolio.

Leggio: In your portfolio.

Akre: On down to our per share price.

Leggio: Sure. So can you talk a little bit about how you came up with that kind of return target for not only yourself, but for the portfolio of companies you own?

Akre: Surely. When I started looking at this issue many years ago, I observed the long-term return in common stocks. The Davidson Report is in the 10% range, and that's over a period of close to 100 years in this country.

And I concluded that the reason that 10% wasn't a make believe number was that it correlated with what I believe the real return on the owner's capital was across all of those businesses, all those years, i.e. a number that is in the low teens.

And it's been our goal, in all of the things that we have managed over the years, to try to produce for our fellow shareholders a compounding of our capital at a rate that was above average, and with a below-average level of risk. And so we fish, if you will, in the pond where the returns on capital are a good deal higher than the low teens. And American Tower is certainly one of them.

Leggio: Well great, Chuck. Thanks so much for joining us today.

Akre: Absolutely, Ryan. Thank you.

Leggio: And thank you for joining us. This is Ryan Leggio for Morningstar.