Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy
[00:00:00] S0: My guests today are Alex Behring and Daniel Schwartz, co-Managing Partners of 3G Capital. 3G has built one of the most distinctive firms in investing around a simple idea – there are only a handful of truly great businesses and even fewer great CEOs, so instead of diversifying broadly, they concentrate deeply. Their model is to raise capital with the intention of making just one investment per fund, commit meaningful amounts of their own money alongside their partners, and focus all their time and the best people on that single opportunity. What sets them apart is that they come to investing as operators. Alex previously ran the largest railroad in Latin America, and Daniel served as the CEO of Burger King, and many of their partners have served as CEOs, CFOs, or senior operators inside of complex organizations. When 3G buys a company, they step in as operators, align incentives with ownership, and work alongside management to improve the business. That approach has produced a series of iconic deals, including Burger King, Tim Hortons, Hunter Douglas, and Skechers. Along the way they’ve also become known for developing talent, giving young leaders real responsibility and ownership, and holding an unusually high bar. Please enjoy this great conversation with Alex and Daniel. Once you’ve heard from Alex and Daniel I highly recommend you also read our in-depth profile on them and 3G Capital. They gave our managing editor Dom Cooke unprecedented access and the outcome is an excellent profile about the 50-year history of 3G, and how the model began with Jorge Paulo Lemann in Brazil. I want to start with this "one investment per fund" concept. Because, first of all, I just think it's extremely cool to think about having a big pool of capital to deploy into one thing, and all the work that goes into that, what ends up being that one thing despite looking at countless other businesses. Where did that concept come from? Because it must dictate so much about the nature and culture of the investment strategy, firm, people. "One investment per fund" sounds interesting, and I know it is from our past discussions. Where did that come from?
· Alex Behring
[00:00:00] S1: So that comes from our Brazilian roots, where my co-founders had done this beer investment that had worked really well. And then, as they branched off into private equity in a predecessor firm, of this firm in Brazil, they attempted a bit of the more traditional approach also. That went okay. But then we understood a couple of lessons from that. One was that really, really great businesses are rare. There are not that many of them to begin with. Secondly, the ones that exist, they are not often actionable. So therefore, if you are going to be in the business of putting a lot of your own capital to work, and if you're going to be very involved, the people that you're going to need to deploy there and the time are also a scarce resource. So when I started the firm in New York in 2004, we already had those things pretty clearly understood. And that was the premise that – to the extent that we would get involved with businesses on a strategic, long-term basis, it would be one at a time.
· Daniel Schwartz, Patrick O'Shaughnessy, Alex Behring
[00:00:00] S2: We have this luxury of only having to find one great business at a time. And I think if you're investing your own capital, and if that's the lens through which you're looking at the investment, you want to be really patient and wait until you find that great business. The other way to look at it is, it's so hard for us to find a great business to invest in. How are we going to find 10? It's so hard to find great people to be great CEOs. So how are we going to find 10? So I think it's great to be able to buy one business every once in a while and send in your A++ players to get involved. [00:00:00] S0: Is there any psychological fear or pressure associated with knowing that it's just one, all eggs in one basket, and watch the basket very closely? Like, what psychology does that feel like? [00:00:00] S1: As much as the psychology, I think it drives the investment process – a very rigorous analysis of what the downside can be. And in our case, the downside has to be capital preservation, with some small return of sorts. And that drives the business side of decisions. And it also drives capital structure decisions. I think that's where it manifests itself the most. If you were to look at businesses that we didn't buy, or deals that we didn't do over a long period of time, I think more often than not, that would be a function of us not being comfortable with a potential downside scenario or a downside case, as opposed to us not finding a path to a great case.
· Alex Behring, Daniel Schwartz, Patrick O'Shaughnessy
[00:00:00] S1: As much as the psychology, I think it drives the investment process – a very rigorous analysis of what the downside can be. And in our case, the downside has to be capital preservation, with some small return of sorts. And that drives the business side of decisions. And it also drives capital structure decisions. I think that's where it manifests itself the most. If you were to look at businesses that we didn't buy, or deals that we didn't do over a long period of time, I think more often than not, that would be a function of us not being comfortable with a potential downside scenario or a downside case, as opposed to us not finding a path to a great case. [00:00:00] S2: I think it's a healthy pressure that we put on ourselves to make sure that we're not compromising on business quality. And we're only – we’d rather do nothing than... [00:00:00] S1: Our capital structure being too stretched... [00:00:00] S2: Yeah, like, we're going to buy a great business. We're going to lever it appropriately, not too much. It definitely makes it harder to price risk. If you think about the traditional portfolio approach, where... [00:00:00] S0: Yeah, it's the portfolio construction part of it.
· Patrick O'Shaughnessy, Daniel Schwartz, Alex Behring
[00:00:00] S0: Yeah, it's the portfolio construction part of it. [00:00:00] S2: Yeah, you have 10 businesses, and if one has some idiosyncratic risk or whatever. It's harder to price risk, so we take that into consideration. But then on the other hand, you have this team here who are really excited to do a great deal. And oftentimes, they're going to bet their own careers, as is the case with Alex and a railroad that he bought in Brazil, as is the case with Burger King that we bought here for me. And so when you're betting your reputation on something, you want to hold it to the highest possible standard. [00:00:00] S0: If you think back to that, the very first days, 2004 or thereabouts, through to today, 20 years. How has your idea of what constitutes a great business changed the most through all of these investigations and running the five, six businesses? What's most changed about your views? [00:00:00] S1: We over the years had to refine our investment process in terms of making that determination of whether a business is great or not, as a function of how the world changed because of technology. The possibilities of a business being disrupted in this day and age, as compared to maybe 20 years ago, are significantly higher. And therefore, the investment process and the investment discussion around disruption needs to be significantly more detailed and thorough.
· Alex Behring, Daniel Schwartz, Patrick O'Shaughnessy
[00:00:00] S1: We over the years had to refine our investment process in terms of making that determination of whether a business is great or not, as a function of how the world changed because of technology. The possibilities of a business being disrupted in this day and age, as compared to maybe 20 years ago, are significantly higher. And therefore, the investment process and the investment discussion around disruption needs to be significantly more detailed and thorough. [00:00:00] S2: Yeah, I agree with that. Disruption and disintermediation. I think we have a greater appreciation today for businesses that own the relationship with their end customers. If you have that, you're less likely, I mean it seems obvious, but less likely to be disintermediated through some new disruptive force. [00:00:00] S0: How did you most learn that specific lesson, the disintermediation lesson? [00:00:00] S2: Since 2004, we’ve followed restaurant businesses. We’ve followed packaged food and consumer packaged goods businesses. And there is this ongoing shift you see in society of the share gain of private label. If you're a large retailer, be it a Walmart or Amazon or Costco, if you own the relationship with your customers, you have this ability to disintermediate the company selling to you. [00:00:00] S0: Kirkland happens, yeah.