00:19:20 · Mikk
[00:19:20] S0: Now when it comes to your research process, you mentioned before you're sometimes jealous for those guys buying businesses in in in the private markets. What would be the obvious things you would do if you would get access to those private companies? Like, three, four things you would you would do, and what would you include to your research process to get the the best best information to make a decision?
00:19:45 · Deiya Pernas
[00:19:45] S1: Well, one of the reasons why, I guess, we're sort of jealous, so to speak. So I think there's a few ways you can you can create alpha in markets. And one of them is really understanding business as well and kinda where they're headed, which is, what we do. I think there's another way you can generate alpha, which is really finding great managers and being very... And being a very good judge of managerial talent and capital allocation talent. And that second way is not the purview of public equity investors just because they don't have the access. Like, you really have to understand somebody very well to know how good they are at managing. Oftentimes there are people that'll say like, Oh, this guy's a great CEO. And maybe it's because they haven't had a really good COO. And then they just happen to have an amazing COO and then COO left. But these are things that if you're a private market investor, you know the management team, you know all these people very, very well, and you're a good judge of character, you're not fooled by charisma or you don't fall for the, you know, a lot of the other traps. Like, you're gonna be able to suss out these really good munitions and essentially bet on people, which is something we can't do in public markets. So that's the part that we're... We wish we could do, but we just can't. We'll we'll just never have the access. Sure. We'll be able to have a few calls of the CEO and even go to their headquarters and meet them, but never will we have that level of access to potentially a private equity investor.
00:21:17 · Mikk, Deiya Pernas, Dean Pernas
[00:21:17] S0: So how is your thought process? How do you actually charge a management team? What makes you conclude that someone is actually a great, great CEO? [00:21:26] S1: So for us, it's for us, it's really just about focus and are they doing what they're saying they're gonna do? And just really just verifying everything that they're saying in the act. Like, we never take anybody to work for anything. You know? So it's really verifying what they're doing with the actual facts, with the actual with the actual data, with expert transcript, [00:21:48] S2: so on and so forth. [00:21:50] S1: And they they really have to have also a talent for capital allocation as well. Like, we think the great CEOs would also make great investors, but the other way around isn't exactly true. Because, you know, managerial talent has come kinda come together with capital allocation talent, which, you know, it's not always intuitive for a great management to also be a good app... Capital allocator. You kinda have to have that investing sense, like, what's too much risk? Am I overpaying for something? Is this... Know, is it a good time to make a really big investment to... In order to gain share in the marketplace? Those are all, like, investor type of intuitions that don't... Aren't easily parallel with great managers. So that's that's what we would consider a CEO. Somebody who's a really good manager and really good kind of investor, those kind of rare skill sets come together.
00:22:43 · Dean Pernas, Mikk
[00:22:43] S2: Yeah. To add to that, I would also say the the lens that the management team brings as well. So at points in a company cycle, it's... The company's dealing with different problems, whether it's an engineering problem at one point, a sales problem at another, and kinda matching where the where the CEO came from that trees up with the... Where the company where the company's needs are most, most demanding. And, also, if they can just... If they elucidate a a well thought out strategy. So it's not like, hey. We're gonna be the market leader in this. It's like, no. We're gonna go after this customer in this geography. And and it's just hyper focused. I forget who said it, but it was like a company is the sum of all the vectors. So you have a tons of employees in the company, tons of managers, and if they're all scattered in different directions different directions, the vectors cancel out, the company goes nowhere. If they're all pointed in the same direction, they're focused, the company can move a lot faster. So it's it's focus, belief in your strategy, and executing. [00:23:36] S0: When it comes to capital allocation, some of the listeners, they may manage two companies, some of them five, some of them 10. We have had on the show someone who manages a portfolio of 160 companies. So based on what you've seen, where can you when can you say someone is an excellent, maybe, capital allocator? What have been some of the examples of someone being exceptional and someone who you've seen made a made a mistake?
00:24:05 · Dean Pernas
[00:24:05] S2: Yeah. For example, Sleep Number is one. So Sleep Number was a company... A a mattress company during COVID that you hear the share buybacks being bandied around by managers just because investors like to hear them for whatever reason. And Sleep Number essentially bought back $800,000,000 worth of shares when the company's... At its peak during 2021. I think it was trading at a 100 or something a share. And, essentially, cash... They depleted cash to zero. Demand for mattresses went down to essentially zero because there's a huge demand surge during COVID, and the company, I believe, went bankrupt. And they could have used that cash as just... They they could have put it in a much more rational way. But it's it's just... It's... To buy back shares pro cyclically versus counter cyclically is just the worst decision. It's like most managers have no idea what the valuation of the company is, and they kind of just do share buybacks to appease investors or to to prop up the share price for options or or whatnot. And that's just the the the worst thing you can do. And to go bankrupt because of of that is just such a horrendous mistake. Then you have the opposite side who's like Henry Singleton at Teledyne that buys back shares. He he existed forty, fifty years ago, maybe more. Buys back shares essentially when they're at decade lows, and he buys back aggressively. So buys back 40% of shares outstanding in the span of two weeks. That's an example of what to do versus what not to do.
00:25:30 · Deiya Pernas
[00:25:30] S1: Yeah. I think like Dean was saying, great litmus test, if they're a decent allocator or a great way to eliminate somebody is what... How their buybacks look like. Most management teams are very happy for for whatever reason, probably because investors seem to celebrate it without celebrate it unconditionally when a company announces about buyback and they'll do it at any price. There is no value considerations when they come go to buying back shares. And we all know that, you know, if you're if you're gonna add to intrinsic value per share, which is really the goal, which should be the goal of every management team, which it's not, but let's just say it is, then you're gonna wanna buy back shares when the price is low relative to the value of the company, not the other way around, not pro cyclically like it's usually done. But as far as maybe some... Something private market investors to take away from capital allocation decisions is just usually how patient a management team is, yeah, how patient a CEO is with maybe an acquisition, if they have evaluation discipline, if they are thinking tactically about opportunities putting capital work in those opportunities. You're looking for somebody who's almost very conservative when the situation calls for it, and then they can kind of turn it on and also be very, very aggressive when when the... And when an opportunity emerges. So that type of kinda, you know, personality, I I think, you know, is is is gonna be a very good capital I get.