Before he started New York-based Atlantic Investment Management in 1988, Alexander J. Roepers spent six years in the industrial world, first with the Dover Corporation, a manufacturing conglomerate, and later on with the Thyssen-Bornemisza Group, a privately-held multi-billion dollar company, where he became Director of corporate development with responsibilities for acquisitions and divestitures. His investment career started as a natural outgrowth of his experience in buying and selling industrial companies as he began to focus on mid-size, diversified manufacturers which were often neglected in the market craze for large cap growth stocks throughout the nineties. Initially, his investments were primarily on the long side but, in February 1993, he started AJR International, an offshore hedge fund which had a more active trading style. One year later, he started a companion partnership, Quest Capital Partners, LP. In 1996, he launched a second fund, Cambrian Fund Ltd. and a companion partnership, Cambrian Partners LP, to invest in a concentrated portfolio of half a dozen medium to low-tech industrial companies, the strategy he had successfully followed since 1992 for a separately managed account. Both strategies have produced strong returns with the AJR strategy compounding at an annual rate of 22.2 % since 1993 and the Cambrian strategy at 33.2% since 1992. Assets under management have grown substantially in the last two years to $640 million currently. Alex spoke to HFN publisher, Antoine Bernheim, in late April 2002.
Profile of Alexander J. Roepers
Born: March 3, 1959 in The Hague, The Netherlands
Education: Nijenrode BBA (1980); Harvard MBA (1984)
Family: Wife, Shafi; children: Jackie (8), Paige (4) and
Last vacation: St. Barths, F.W.I.
Last book read: The Complete Tales by Beatrix Potter (to my daughter)
Favorite quote: "as in driving a car, in both life and in managing money, I prefer to look through the windshield and rarely glimpse in the rearview mirror"
How he best describes himself: "Family-oriented, persistent, disciplined, optimistic and trying hard to not take himself (or life’s travail) too seriously"
Q. Could you describe your investment philosophy?
A. We are bottom-up, value-driven investors in U.S. companies with market capitalization between $500 million and $5 billion. We look at these companies as if we were going to acquire them outright with borrowed money. We look for investment grade companies which have never lost money over the last ten years. Further, we avoid entire sectors which do not lend themselves to our private LBO approach, such as technology, bio-technology, financial services, highly cyclical companies or companies with significant government interference or product liability risk. As a result, our long universe is a well defined and somewhat narrow group of approximately 250 companies. We look primarily for two things: (a) predictable and reliable sales and cash flows; and (b) strong free cash flow yields of 10% or more at our entry point, so that in part through the passage of time, the value of our investment improves as these companies pay down debt. The predictability and reliability of sales and cash flows are derived from their products and services which are consumable, repair and maintenance types rather than capital spending dependent types. The predictability is further enhanced by a diverse customer base, a broad product portfolio serving many industries and regions as well as by having time-tested products with minimal risk of technological obsolescence. On the long side, we typically scale into new positions at 4.5-5.5 x EV/EBITDA, while we are also disciplined about scaling out of our long positions at 12 to 15 times forward EPS. Because our universe is relatively narrow, former core longs often come back into the portfolio after a stock has dropped on disappointing news. One company has returned to the funds as a core long four separate times over the last eight years. On the short side, we undertake fundamental research to identify companies mostly chosen from within our long universe, which are either highly overvalued, technically overbought and/or over-leveraged or have legal liabilities.
Q. Could you describe your research process?
A. We do our own research and our own comparative and competitive analysis. We interact with management through field visits and we are typically the most involved buy-side party in the company. We enhance our due diligence and judgement on the companies and their management by being pro-active, constructively engaged shareholders. Through close interaction with the company management on shareholder value enhancing ideas, we typically create important due diligence opportunities. Often our involvement may actually accelerate or enhance the process of creating shareholder value. We don’t engage in proxy or legal battles because that would restrict our liquidity and cut off the information flow from management.
Q. Could you describe how you manage market exposure?
A. Our net exposure in the hedge fund ranges between 0% and 90% (most of the times between 20% and 60%) with our gross long ranging from 40% to 100% and our gross short from 10% to 40%. Our gross long exposure is purely a function of our buy and sell discipline. When stocks in our universe reach 4.5 to 5.5 times EV/EBITDA multiples, we buy, and we sell when they reach 12 to 15 times forward earnings per share. Currently, we are somewhat under-invested as value stocks have done well in the last two years. In 2001, we ran into a number of selling opportunities and have since not seen enough buying opportunities to replace the stocks we have sold. On the short side, we always have a number of fundamental short positions, regardless of our view on the market. Our valuation shorts, which include mostly "paired trades" and retailers, as well as our market shorts, a selection from the top 30 market caps in the U.S., are typically put on and taken off based on equity markets technical indicators, such as the volatility index or put-call ratios and when we feel the market is at risk after a substantial run-up. We typically reduce our short exposure by covering the valuation and market shorts after a fairly climactic 10%+ type decline in the NASDAQ index.
Q. How do you control risk?
A. First, we want to make sure that we have good liquidity in all positions, which is not a problem in any of our positions, except the larger core long positions. We typically have ten to fifteen longs with the top five or six positions being core longs (these are the Cambrian stocks), each representing between 5% and 15% of our equity and the other longs being between 2% and 5% of our equity. We typically own between 2% and 6% of the outstanding shares of our core longs and we want to make sure that we have 30 days or better trading liquidity based on average trading volumes. Our main risk control tool is our strict universe, as well as our selection and valuation criteria. Clearly, the concentrated approach of a fund like Cambrian results in above market volatility, but I do not believe that this necessarily implies greater risk. In fact, over the last ten years, among our core longs, we have only had one realized loss, which was taken primarily as a portfolio management decision to reduce exposure at an uncertain time in 1998. We do not work with stop-losses on the long side. On the short side, where a typical position is between 1% and 2% of capital, first, we limit the total short exposure to a maximum of 40% and second we cut back short positions after they go 30% against us. Our risk management has evolved since the early years of our hedge fund, particularly on the short side where we have reduced the individual size of our positions, introduced a categorization of our shorts between fundamental, valuation and market shorts in order to reduce correlation among them and put a limit on the maximum short exposure. In the last five years, the returns of our hedge fund and our core long fund have been quite similar but the volatility of the hedge fund has been considerably smaller.
Q. What is the mix between trading and investing?
A. On the long side, we are first and foremost investors and we hold our core longs between one and three years and the other longs between six months and a year and a half. However, we have clearly benefited from trading when our core positions have had big moves. Trading has typically added between 2 and 5 percentage points annually to our performance. On the short side, we are active traders as we hold our positions typically between two weeks and two months and market movements are largely responsible for most of the trading on the short side.
Q. Could you describe the circumstances that get good companies into your strict valuation parameters?
A. For example, Dole Food (DOL, $33, NYSE) was on our radar screen for a long time. In late 2001, they announced the divestiture of a Honduran brewery for $540 million which allowed them to pay down half their debt. The company suddenly became attractive on a valuation level. We had already done a lot of homework and the moment the deal closed, we started to scale into the company. Another example is Cooper Industries (CBE, $44, NYSE), a manufacturer of electrical products, which we shorted last year after it received a takeover bid from Danaher. The stock reached $60 when we shorted it in August at 10 times cash flow. We felt that it was not going to go higher and we went against the arbitrage community with the idea that, at a minimum, the stock would get weaker along with that of the acquiring company. We believed that there was a chance that the deal would unravel which happened in the fall. We covered it at $38 and, in January 2002, we went long the stock, based on our view that the asbestos fears were overblown. We established a core position in the low 30s, when the stock was selling at 10 times depressed net earnings and paying a 4% dividend. We feel that the company can return to $60 a share within a year and a half, based on a 15 times earnings multiple on estimated 2003 EPS. It is currently our second largest long position.
Q. What are your goals for the future?
A. We currently have nearly ten years of audited records well in excess of 20% net of fees for both of our strategies. It is my primary professional goal to try to achieve similar rates of return over the next ten years. With regard to staffing, there are currently five of us, including two senior equity analysts and two support staff, and I am close to hiring a third equity analyst. Regarding assets under management, we are likely to close in the near future when we reach the $1 billion level.