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Danoff: The Benefits of Being Big

Katie Rushkewicz Reichart, CFA

Katie Reichart: I'm Katie Reichart with Morningstar. I'm here with Will Danoff of Fidelity Contrafund. Thanks for being here, Will.

Will Danoff: Thanks for having me, Katie.

Reichart: You and your Fidelity analysts meet with hundreds of CEOs each year. What do you look for in company management, and what gives you pause.

Danoff: Katie, it's really fun to be at Fidelity. It's very exciting; it's sort of like a big-city hospital. We do see a lot of companies come in, and I'm really looking for managements that are very knowledgeable about their companies, knowledgeable about their industries, who are excited about their businesses. Often these are entrepreneurs and founders, who really have seen an industry and watched it or may be even been part of the creation of the industry. And, I just want to try to have them talk about the future, where they see the biggest opportunities, where their highest priorities are. And then the beauty of Fidelity is that we can monitor their progress and check in, six months later, three months later, a year later.

I talk to these companies, I do keep my notes, and then I try to understand what they've done and where they've fallen short. Everybody makes mistakes. As you know the world was not built in one day, issues happen so just how they handle their issues, how they handle different competitive responses. As we talk about often, the best insights are when managements talk about their competition or talk about bigger issues like China or what's happening in the government. By asking the right questions, in many ways, you and I are in the same industry. What's the right question to ask? And hopefully if you ask good questions, you can engage with management and try to get them off of a script.

So it's fun, and very often you see its lucky, because you meet a lot of smart people. They've gotten to the top because their passionate about their business, and you can learn with them. In some cases you can really, over a long period of time, feel like you are a student to a great business person and get insights into a particular industry.

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Reichart: How do you view capital allocation. We've seen a lot of merger and acquisition activity recently including some from your holdings such as Apple buying Beats and Facebook buying WhatsApp. How do you view if that’s good from your standpoint?

Danoff: As you say, capital allocation is so important because we meet these management teams, and ultimately you are trusting the management to do the right thing. So often the team and I will look and say, "Does this management team have the same interests as we do? Are they owner operators?" If they are you can assume that the they are not going to do things that really are irrational or value-destroying. Sometimes management teams, even if they're large shareholders, delude themselves. Sometimes they get caught up in the hype and they make a bad acquisition, but clearly what can you do as an observer of companies? How is management executing on their plan? How are they thinking about their plan? And then ultimately, what are they doing with the cash that they generate.

So you can analyze a business. Is this a good business; is this generating cash? And then is management strengthening the moat, defending the moat, and widening the moat? And then are they hopefully playing the cycle wisely at the bottom, acquiring assets, so that when the cycle turns they are bigger and better and avoiding at the top doing something that can be disastrous for the company? So I think it's very, very important.

Often you can just ask, "Why are you doing this?" And hopefully management has a well-thought-out answer, and hopefully they can execute. And again if you put it through the lens of "Is this making the franchise bigger, better, and stronger?" then that should be a good thing. And then you've got to decide whether they paid too much for that.

Sometimes it's a matter of, what we talked about with WhatsApp, there is risk to that business. But it makes some sense. Perhaps Mark Zuckerberg felt that if he didn’t buy it, someone else would, and that would be a threat to him. So maybe you look again, and say maybe the Facebook franchise is not as strong as I thought it was if he's worried about instant messaging.

So, you watch what smart people are doing and over time, the beauty of our business is we can monitor and see how things play out. And again, this is all a batting average, so even the best companies make bad acquisitions. Hopefully they don't make acquisitions that destroy the company.

Reichart: Contrafund is one of the biggest funds out there. So how do you manage with such a large asset base?

Danoff: There are advantages to being a large fund, Katie, as you know. I can be the largest shareholder of many of these companies, so managements are willing to talk to us, and I try to be respectful of their time and ask very strategic questions. We've got a great research department at Fidelity. So we're monitoring virtually every industry all over the world. We've got people in Mumbai, Tokyo, Hong Kong, and London, and that just enables us, I think, to monitor the whole sort of capital scene on a global basis. Sometimes the insights in technology don't start in Silicon Valley, but they might start in China or Taiwan or Hong Kong or Tokyo, and hopefully if we are all communicating well and sharing our ideas and working for the shareholders, we will see certain trends a little bit beforehand.

I'd say the other opportunity with size is just need to think longer-term, and to take bigger positions. And by taking bigger positions you really have to think and try to say, I can't buy today and sell next week that won't matter. I'm really looking for multiyear megatrends. Then as you said earlier, management becomes more important because you are going to be a partner over a long period of time. It's almost like getting married and hopefully everyone is happily married. But you're in it through the good times and the bad times.

Also I think more interest in the quality of the team, the quality of the business, and the culture has become more and more important with me just trying to invest with companies I feel comfortable with, management teams I feel comfortable with that are hardworking and honest, love their business, and over time are going to grow their business and build value for shareholders. But being a large fund has a higher degree of difficulty. I'm working harder than managers who have smaller asset bases. It's a little harder for me to build positions.

You just try to work to your strengths and avoid making mistakes. I mean it's sort of like competition. You want to avoid unforced errors; you want to avoid these easy mistakes. And then you just have to play the game. You've got to concentrate. You can't worry too much about the score as we talked about earlier, and you have to just try to identify companies that are going to be bigger and better. I sometimes show up in a meeting unprepared, and I can ask the management team where they think a company is going to be in four or five years. What are the strategic issues they feel they have to address? In the back of my mind, is this company going to be bigger and better in five years. If I am not sure, that’s OK. But I have got to factor that into the analysis.

Reichart: Will, thanks for being here.

Danoff: Thank you, Katie, it's been a pleasure.

Reichart: I am Katie Reichart with Morningstar.