Profiles in Investing, 03/2006
Burkhard Wittek
FORUM Family Office, Munich
By Christian Mienert
Welcome to "Profiles in Investing", brought to you by The Bottom Line and The Heilbrunn Center for Graham & Dodd Investing. This series aims to profile leading investors to get an inside look into their investment philosophies.
Germany is famous for Lederhosen-clad luxury car producers and yodeling engineers, but serious value investors can also be found in this European country - investors who are quite succesful. Burkhard Wittek has been investing since his 12th birthday. His talent in assessing the strenghts of companies' business models has allowed the 52-year old investor to achieve a compounded annual return of 45% p.a. in the last 5 years.
When did you start to invest in stocks?
At the age of 12 years I started to manage my father's broker account. My parents were both scientists and had very little knowledge about money and investing. The first company I invested in was a German textile mill with huge hidden reserves in real estate called Kottern. It was bought out shortly thereafter. Those years must have ignited a strong love and passion for the topic of investing in me.
What did you do after High School?
I did a trainee program at a German bank to learn how financial institutions work. Then I studied business administration in Germany, followed by a MBA at Harvard. Afterwards I worked for the Boston Consulting Group for 13 years. One of the key frameworks of BCG was that there are parameters making a business inherently strong or weak. The key was to look outside of a company, understanding customers and competitors in-depth. BCG also pioneered strategic portfolio management: our job was to re-direct corporate resources from the structurally weak businesses to the good or outstanding ones. We also tried to fix weak businesses - which required a lot of management's energy and often lead nowhere.
What are the ingredients of a good business?
80% can be explained by the parameters "customer interface" and "competitive advantage". In customer interface we look for aspects defining stickiness and visibility of revenues, e.g. share of after sales business, quantifiable user economics, razor/razorblade revenue models, or switching costs.
For competitive advantage we look at the relative share of the company compared to its competitors in things like brand awareness, share of channel or shelf space, cost positions or intellectual property. In many digital businesses network economics create a huge competitive advantage for the guy with the highest market share and the highest number of users.
Financially, these characteristics will translate into a high Return on capital Employed (ROCE) and Cash Flows. If the business then has the chance to re-invest those funds into growth at the same outstanding returns, you have internal compounding working for you. The "average" we own has 101% after-tax ROCE and grows organically by more than 40% p.a.
That is Buffet's main contribution to investing: the human mind tends to think in a linear fashion and vastly underestimates the power of the compounding economics. When you can see a short term inflection point on top of that you have the perfect buying opportunity. Based on your framework you pay a reasonable price while the market prices in earnings that are greatly underestimated.
For competitive advantage we look at the relative share of the company compared to its competitors in things like brand awareness, share of channel or shelf space, cost positions or intellectual property. In many digital businesses network economics create a huge competitive advantage for the guy with the highest market share and the highest number of users.
Financially, these characteristics will translate into a high Return on capital Employed (ROCE) and Cash Flows. If the business then has the chance to re-invest those funds into growth at the same outstanding returns, you have internal compounding working for you. The "average" we own has 101% after-tax ROCE and grows organically by more than 40% p.a.
That is Buffet's main contribution to investing: the human mind tends to think in a linear fashion and vastly underestimates the power of the compounding economics. When you can see a short term inflection point on top of that you have the perfect buying opportunity. Based on your framework you pay a reasonable price while the market prices in earnings that are greatly underestimated.
Why did you leave BCG?
I wanted to learn the operating side of business and fix companies that other managers had not been able to fix. Also, I wanted to transform my work into wealth. I founded a Private Equity fund in 1990 together with a partner. We invested in turnaround situations and took an active part in running the acquired companies.
At full liquidation of the fund in 2001 we had achieved an annual return of 61% per annum. That was great. But 85% of the results came from one investment which was also the easiest to manage, a fire extinguisher company. They had 70% of sales in service and spare parts with margins that were great because no user bothered about this insignificant part of his total purchasing. We increased prices by 30% and that did it. After liquidating the Private Equity fund in 2001 I wanted to continue investing - but with a much stronger focus on outstanding businesses. That led me to the stock market. I think that it offers more outstanding companies than the private market even with a good deal flow.
At full liquidation of the fund in 2001 we had achieved an annual return of 61% per annum. That was great. But 85% of the results came from one investment which was also the easiest to manage, a fire extinguisher company. They had 70% of sales in service and spare parts with margins that were great because no user bothered about this insignificant part of his total purchasing. We increased prices by 30% and that did it. After liquidating the Private Equity fund in 2001 I wanted to continue investing - but with a much stronger focus on outstanding businesses. That led me to the stock market. I think that it offers more outstanding companies than the private market even with a good deal flow.
What has been your investment approach since make investing in the stock market your core business?
In screening we concentrate our efforts on finding great businesses - like fire extinguishers. I think we have developed a set of 50 - 100 frameworks that help us to recognize such a business. (I have given you some examples when explaining customer stickiness and competitive advantage, but we have developed many more). That is the most valuable capital of our firm.
We commit more time to doing due diligence on a targeted business than any other stock market investor I know. With four professionals we only made one investment in 2004 and 2005. We really want to understand what we own. We spend a lot of time in the field interviewing customers and competitors. One day in the field gives you as much insight as 10 days in front of your computer screen. We also increasingly try to assess the people who run the business in a more systematic manner. The best investment for the long term are those where the owner and the manager allocate resources by the same framework: the owner to companies and the manager to his CapEx and daily resource allocation decisions.
We commit more time to doing due diligence on a targeted business than any other stock market investor I know. With four professionals we only made one investment in 2004 and 2005. We really want to understand what we own. We spend a lot of time in the field interviewing customers and competitors. One day in the field gives you as much insight as 10 days in front of your computer screen. We also increasingly try to assess the people who run the business in a more systematic manner. The best investment for the long term are those where the owner and the manager allocate resources by the same framework: the owner to companies and the manager to his CapEx and daily resource allocation decisions.
You found an outstanding business in BetandWin. James S. Chanos the expert for shorting stocks rather recommends to sell internet gambling portals because of the low barrier of entry. Why is BetandWin in your portfolio?
BetandWin offers online poker which has network economics. The necessity to have a large community of gamblers and provide high liquidity generates high barriers to new entrants. I think the top 5 online companies will jointly increase their hold on the market - and try to limit pricing pressure.
The other parts of the business, online fixed-odds betting and casino, do not have these network economics. Therefore I expect increasing competition and strong margin pressure. I think the management at BetandWin has understood this and is re-positioning its offer towards an integrated betting/entertainment package. They just bought the TV rights to the German Premier League outside of Germany for €80m. And more than 50% of their bets are already live bets. Most likely gamblers who bet during a game will not compare odds - they want convenience.
The other parts of the business, online fixed-odds betting and casino, do not have these network economics. Therefore I expect increasing competition and strong margin pressure. I think the management at BetandWin has understood this and is re-positioning its offer towards an integrated betting/entertainment package. They just bought the TV rights to the German Premier League outside of Germany for €80m. And more than 50% of their bets are already live bets. Most likely gamblers who bet during a game will not compare odds - they want convenience.
