Smart Money Masters — August 2017 Issue

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

Betting on a Tiger Cub’s #1 Technology Bet

Your Smart Money Masters portfolio continued to march to the beat of its own drummer in an otherwise mostly quiet month in U.S. and global stock markets.

Wilbur Ross’ bet on Navigator Holdings (NVGS) rebounded an eye-popping 19.58% after suffering a massive decline in the prior month. Bill Ackman’s Restaurant Brands International (QSR) rose 2.80%. Warren Buffett’s Berkshire Hathaway (BRK-B) recovered 2.79%.

More interesting were the opportunities that the U.S. stock market threw up this past month in the form of the biggest bets of two of the top investors in the world: the inimitable pair of Charlie Munger and Warren Buffett.

The curmudgeonly Munger’s bet on Costco Wholesale Corporation (COST) fell 15.42% this past month after Amazon’s proposed acquisition of Whole Foods Markets (WFM). This pullback is a terrific buying opportunity that comes along rarely for a stock like Costco, which continues to thrive. The company just posted a robust global comparable sales growth figure of 6.5%. Its membership model protects it from Amazon since Costco makes most of its profits from membership fees. And Costco’s unique buy-in-bulk business model was never even in Amazon’s crosshairs.

Warren Buffett’s big bet on Kraft Heinz (KHC) fell off a cliff last month to cause investors some indigestion. The stock’s tumble of 11.44% is also classic overreaction. In this case, however, the cause is due to non-existent news.

Let’s review Kraft Heinz’s fundamentals. Managed by some of the top private equity investors in the world, Kraft Heinz has been able to generate higher profits on cost savings, even among lackluster sales. As of first-quarter 2017, the company realized cumulative savings of approximately $1.3 billion. Zero-based budgeting, modernization of factories and building a performance-driven approach ensure that the firm will generate significant gains for patient investors like Buffett.

Both Charlie Munger and Warren Buffett are likely dancing in celebration of the recent sell-off in Costco and Kraft Heinz. Both are textbook examples of “Mr. Market’s mood swings” which offer patient investors a rare opportunity to buy stock in world-class companies at bargain basement prices. I wouldn’t be surprised if it turns out that both Munger and Buffett are buying these stocks aggressively. You should, too.

The World’s Top Consumer Travel Portal

This month’s Smart Money Masters portfolio recommendation, The Priceline Group Inc. (PCLN), is a consumer-technology play in the high growth world of online travel. Priceline is also the largest position in “Tiger Cub” and Julian Robertson’s protégé Chase Coleman’s Tiger Global Fund. The fund has invested a whopping 18.93% of its assets in the company.

As you may know from the corny TV ads with the original Star Trek’s William Shatner, Priceline is the online travel company that pioneered “name-your-price” travel services. In addition to the Priceline brand, Priceline also operates Booking.com, Agoda.com and Kayak.com.

Shares of Priceline have been in a steady uptrend for most of the past decade to rise an astonishing 2,012% over the last 10 years. That works out to an average annual return of just over 39%.

By way of comparison, the Nasdaq returned an average of 11.94% over the same period.

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How Julian Robertson Got Chase Coleman His Start

Julian Robertson is one of the founding fathers of the hedge fund industry. He launched Tiger Management in 1980 with $8 million. At its peak in 1998, Tiger was managing over $22 billion. Between 1980 and 1998, Robertson returned 31.7% per year after fees, crushing the S&P 500’s 12.7% annual return. Robertson stopped managing money for his clients in 2000, after the dot-com bust. He then shifted his attention to nurturing young investment talent, including this month’s featured manager, Chase Coleman. Today, at the age of 84, Robertson is still widely followed in the financial media. And Coleman, exactly half Robertson’s age, is already a billionaire twice over.

When he started the original Tiger Fund, Robertson focused solely on U.S. stock markets. Much like the father of the very first hedge fund, Alfred Winslow Jones, Robertson went long on the best companies and shorted the worst companies he could find.

As Robertson put it: “I believe that the best way to manage money is to go long and short stocks. My theory is that if the 50 best stocks you can come up with don’t outperform the 50 worst stocks you can come up with, you should be in another business.”

For Robertson, the investment thesis surrounding an idea is key. The thesis has to be simple, logical and supported by research. Before Robertson pulled the trigger, each Tiger analyst had to summarize the investment thesis into an easy, understandable four-sentence idea. Robertson would then stick with the concept through thick and thin until the underlying thesis changed. Robertson was also an aggressive investor who was willing to take massive positions. He summarized his investment process this way: “Smart idea, grounded on exhaustive research, followed by a big bet.”

 

Rise from “Tiger Cub” to Head of Tiger Global Management

Charles Payson “Chase” Coleman III is the founder of Tiger Global Management. A descendant of the last Dutch governor of New York, Coleman grew up in on Long Island and was educated at the tiny Deerfield Academy in Massachusetts. He graduated from Williams College in 1997, where he was a lacrosse jock.

Coleman won the genetic lottery by being born into “old money.” In 2005, Coleman married Stephanie Ercklentz, who was featured in the film Born Rich, a 2003 documentary about growing up in the world’s richest families.

Coleman started his career in 1997, working for Julian Robertson and his hedge fund, Tiger Management. How did he get his foot in the door? Coleman had grown up with Robertson’s son, Spencer.

In 2000, Robertson gave Coleman $25 million to manage, making him one of the 30 or more so-called “Tiger Cubs,” fund managers who started their fund management careers with Tiger Management.

Coleman is one of the more successful Tiger Cubs. Tiger Global Management returned 71% after fees in 2007. By the end of 2007, Tiger Global’s annualized return since inception stood at 44%. Tiger Global lost 26% in 2008 and was up only about 1% in 2009. Coleman returned 45% in 2011, 23% in 2012, 14% in 2013 and 17% in 2014. Today, Coleman’s Tiger Global has around $23.6 billion under management.

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Coleman was ranked #722 with a net worth of $2.4 billion on the Forbes 2016 list of the world’s billionaires. He ranked sixteenth on the Forbes 2016 list of Highest-Earning Hedge Fund Managers by receiving an estimated $200 million in compensation during 2015. That’s pretty good for a guy who turned 42 last month.

Coleman is notoriously publicity-shy and has not been photographed for any publication since his 2005 wedding, from which the above photo was taken. Coleman also refuses interviews, which is why this month’s interview is with his mentor, Julian Robertson.

The Roar of the Tiger Cubs

More than his remarkable track record, Robertson greatest legacy is his “Tiger Cubs” – a group of young investment managers he mentored much like a coach would a sports team. Over the years, Robertson incubated close to 40 hedge fund managers, many of who ended up among the best in the business.

As a group, Robertson’s Tiger Cubs returned 11.9% per year between 2000 and 2008. That compares to an annual loss of 5.3% per year for the S&P 500 index over the same period. That means that as a group, the Tiger Cubs trounced the S&P 500 index by more than 17 percentage points per year! Today, Robertson’s Tiger Cubs manage more money than Robertson ever did. In addition to Chase Coleman, three other Tiger Cubs, Andreas Halvorsen, Stephen Mandel and Philippe Laffont, have become billionaires.

Chase Coleman and Tiger Global

One of the most successful of the Tiger Cubs has been the mysterious and publicity-shy Chase Coleman. Robertson seeded Coleman and his fund Tiger Global with $25 million in 2000. Since then, Tiger Global has generated compounded annual returns of 22% after fees. That compares with annual returns of 6% for the S&P 500, 6% for the MSCI World Index and 7% for the Nasdaq Composite.

Tiger Global owes much of its success to its strong focus on technology. Over the past 13 years, Tiger Global has invested in more than 100 e-commerce and online classified businesses in both its public and private equity funds. These investments included big winners like Facebook, LinkedIn and Zynga. Tiger Global reputedly made over $1 billion on its investment in Facebook alone. The most important theme in Tiger Global’s portfolio today is the consumer internet, most notably e-commerce and online classifieds. That helps explain its current big bet on Priceline.

The Investment Case for Priceline

Julian Robertson insisted that his Tiger Cubs summarize an investment thesis succinctly in four sentences. I will do something similar by setting out four primary reasons why Priceline remains an excellent investment.

I. Growing Market Share in a Growth Industry

Priceline is operating in a growing market. The global online travel market is expected to hit $817.5 billion by 2020, up from $564.9 billion last year. Priceline has been a strong outperformer within the industry. While the market grew by 9.5% over the past two years, Priceline has managed to deliver a 16.3% growth rate over the same period. Its market share also has grown from 10.7% in 2014 to 12.1% in fiscal year 2016. Priceline’s brand, international presence and lean business model have allowed it to establish a moat to keep both current and future competitors at bay.

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II. A Superior Business Model to Major Rivals

Priceline’s top competitor is Expedia (EXPE). In 2016, Priceline’s 12.1% market share was marginally below Expedia’s 12.8% share. More important is the fact that both Priceline and Expedia are part of a duopoly with dominant pricing power in online travel. You may know there are many online travel aggregators, including Kayak, Agoda, Travelocity, Orbitz and Booking.com. What you may not know is that each of these brands is owned by either Priceline or Expedia. When you include all of their subsidiaries, Priceline and Expedia together account for two-thirds of the global online travel-booking industry and 95% of the market in the United States.

Despite their similar market share, Priceline has a distinct edge over Expedia because of its business model.

Priceline’s biggest property, Booking.com, is based on the capital-light agency model with no cost of revenues. In contrast, Expedia uses a merchant model. That makes Priceline more operationally efficient. Specifically, Priceline had an average take rate of 16.4% over the last three years. In comparison, Expedia took an 11.6% cut of its total gross bookings. That also explains why Priceline had higher revenue in each of the last three years despite Expedia generating higher overall gross bookings.

III. The Network Effect

Priceline currently has over 1,000,000 properties listed on its various platforms. Expedia has only 385,000.

That’s mostly thanks to Booking.com, which is the market leader in Europe. Through Booking. com, Priceline has been able to aggregate a large number of properties in this notoriously fragmented market.

Priceline’s larger online travel booking network is a key to Priceline’s better growth prospects. As more visitors come to Priceline’s properties, more hotels list their inventory on these sites to get bookings. These, in turn, attract more suppliers to advertise on the site. Priceline’s recent strong growth in hotel stays demonstrates the strength of this virtual circle.

IV. Attractive Valuation

A growing market share, a superior business model and exponential growth of its network make Priceline an attractive investment. Its attractive valuation is just another bonus.

Despite its superior growth prospects, Priceline trades at a discount to its peers in the online travel space. Priceline currently trades at a priceto-earnings multiple of 43.31 and a forward multiple of 22.38 for 2018.

While it is less expensive than its competitors, Priceline stock is hardly cheap. That said, Priceline tends to handily beat earnings expectations. So Priceline may turn out to be a better value than it looks today.

Overall, a history of stable and growing profits, higher profit margins and a larger network make Priceline a better bet than rival Expedia in this fast-growing online consumer space.

So buy Priceline Group Inc. (PCLN) at market today and place your stop at $1,610. I have given this recommendation a risk rating of 3.

Sincerely,

Nicholas Vardy

Nicholas A. Vardy

Click here to read the August Smart Money Masters Newsletter.

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