Master of the Turnaround

published 28 February 2007

"Any baboon could do what I do," says David Williams in this interview. He's being far too modest. Very few humans have done what he has, which is to compile one of the most sterling investment records going. Since he took over the euphoniously named Excelsior Value & Restructuring fund (symbol UMBIX) in 1992, it has returned an annualized 17%. That's six percentage points per year better than Standard & Poor's 500-stock index. And by the way, Value & Restructuring whipped the index 11 of those 14 years. So let's put baboons aside and concentrate on what makes Williams tick.

It turns out that what Williams meant by invoking baboons is that he has a method of investing that has become as natural and comfortable as his own skin. So, sure, to him it seems easy. To learn about those methods, we chatted with Williams at his firm's Manhattan headquarters. We found Williams, who had come in for the day from his office in suburban Essex, Conn., east of New Haven, to be disarmingly unassuming and an investor who likes to keep things simple.

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Does the P/E have to be low on an absolute basis, or low relative to the market or to a company's growth rate? Right now, it's mostly relative. For example, the overall market sells for about 15 times estimated 2007 earnings. So I won't buy anything for more than 13 times earnings. Of course, it depends on the industry. Thirteen times is pretty expensive for a bank, and 13 times is pretty cheap for a tech stock. At any rate, I recently bought Rockwell Automation in the high $50s and it was trading at about 13 times estimated '07 earnings of $4.60 a share. The stock had sold for nearly $80 in 2006. It went down to the $50s, and I thought that was crazy for a company with return on invested capital of something like 28%. The company has done an awful lot of restructuring, selling off some of its old-line businesses and focusing more on businesses that rely on intellectual capital [Rockwell's main lines are control systems and power systems]. It is well managed, and I was willing to pay up to 13 times earnings for a company that is much more profitable than most of the others I own.

Where do you get your ideas? Here and there -- no place in particular. With a lot of companies that look interesting, I just put them on my screen and stay up with them. When a stock looks cheap or has declined for what appears to be temporary reasons, or if a company is doing something of note -- say, it has new management or has updated its business plan -- we get interested. Plus, one of the nice things about having been around so long is that you develop good contacts on Wall Street. I have three or four brokers in particular who know what I like and will give me ideas.

When was the last time you had cash that you didn't feel like investing? For the most part, I've had very little cash over the past four or five years. When the Fed was tightening the past couple of years, every once in a while I would say that this is nonsense -- the market can't go up with the Fed pounding on us like this. But, like I said, I always found something to buy. I caution people who are getting into investing not to listen to all that stuff on CNBC.

So you don't leave the monitor on during the day? Oh, no. I don't even have one in my office. The problem with CNBC is that they throw so much at you, and you have to somehow put it all together and make sense out of it. Look, this isn't that hard. Don't play the momentum game; buy for the long term. You just buy cheap stocks that no one else wants and invest in companies that you expect to be around for a long time. I think any baboon could do what I do.

The fund-data providers call your fund large-company value. Is that accurate? We are multi-cap value. We do mostly large cap and mid cap, with a little bit in small companies. Companies that are restructuring are typically large. As companies become large, it becomes harder for them to grow. Companies recognize this and do something about it. But we also categorize as restructuring companies that are in consolidating industries. Typically -- but not all of the time -- these are midsize companies, often in the oil business, that don't quite have the wherewithal to compete with the big guys. Those kinds of companies make good investments. They often get taken over by larger companies.

There must be a reason ConocoPhillips is so cheap. Yes, there is always a reason, and it's good to understand the reason. Conoco's profit margins are not as high as Exxon's, and Conoco's profitability does not compare to Chevron's, either. But the guys who run Conoco are getting paid to perform as well as their competitors and will make the changes necessary, including restructuring, to get to the point that their company is as profitable.

Take us through the process once you get an idea. The first thing we -- I and my three associates -- want to do is talk to management. There are two schools of thought about this. One says that you need to talk to management to help understand a company. The other says that management's performance is embodied in the numbers and that management will only tend to mislead. We just get more of a comfort level listening to the managers talk about what they are trying to accomplish. If this is a restructuring company and the stock looks cheap to us, we want to get a sense of whether the company will be around in five years. We want to know if the pitfalls are temporary, and we want to know what management is going to do to try to correct this situation. Once management gets on a roll -- once the business plan is executed and profit margins start to improve -- let me tell you, this really works. We input the expected margin improvement and come up with our own simple earnings model. Assuming that earnings can recover to the level that we expect them to, we input a price-earnings multiple on our expected earnings, and voilà, we have a price objective. After we buy, we hold on to the stock until we think that the restructuring has been completed. Many times, this can take decades -- literally. However, anything trading at more than 20 times earnings is probably ripe to sell in a value portfolio. We also sell when we make a mistake. Usually, we give a company a year or two. If the fundamentals don't match our expectations, we sell.

The big credit-card issuer? Yes. This isn't so much a cost-cutting restructuring as it is a kind of refocusing of the entire business away from cards and toward banking. The company bought Hibernia National Bank, in New Orleans, and it has just purchased North Fork Bank, in New York. So Capital One is redeploying its capital so that it can go from being a very good card company to a company that focuses more on traditional banking. It's very well managed and I like the business. So I bought the stock at about nine times earnings. Regional banks trade at about 12-plus times earnings.

Does a beaten-down drug stock, such as Pfizer, interest you? We like to buy companies whose earnings are going up, not down. We don't like Pfizer's fundamentals. We don't like its pipeline of new drugs. The company is bloated. It had very poor management. And if the Democrats have their way, things will go from bad to worse. Now, all of this is in the price of the stock, so you have to have a lot of conviction that the market is wrong and that you are right. I don't feel that way about pharmaceutical stocks in general.

Do you ever buy a stock in anticipation of restructuring? Yes. One example is Black & Decker, one of our largest holdings. We bought it in 1999, near the peak of the tech cycle, at eight times earnings, before the company announced a restructuring. I've known the company for a long, long time. It wasn't growing much and didn't generate particularly good cash flow. But it operated in a nice little niche and had great R&D. And then it started moving manufacturing overseas and reducing the number of items it sells. The stock did nothing for two or three years, then all of a sudden, earnings started to take off. Some of that was tied to the housing market, even though Black & Decker says that only 20% of its business is real estate-related. At any rate, the stock trades at 12 times earnings now, and we still think it is a good buy.

What kinds of returns do you tell friends to expect from your fund? I honestly believe I'm the last person to ask. But here is what I say: On the downside, we've had a tailwind from value investing for seven years. One of the truisms of our business is that there is a regression to the mean. So I'm a little bit nervous that growth stocks will eclipse value stocks. On the upside, the market sells at 15 times '07 earnings, but in this kind of low-interest-rate, low-inflation period, the market should sell for 18 to 19 times earnings. I don't know what my fund is going to do relative to growth stocks or international stocks, but this is a good time to be buying stocks.

Postscript. The future of Excelsior Value & Restructuring is clouded for two reasons. First, Charles Schwab is selling U.S. Trust, which runs the Excelsior funds, to Bank of America; B of A could slap loads on the Excelsior funds. In addition, Williams, who is 64, says he plans to retire in 2009. Our advice: Buy his fund now. If you do and B of A does begin charging commissions, you'll almost certainly be allowed to make subsequent investments without paying the sales charge. As for Williams's retirement, take advantage of his talents now and worry about the manager shift when it happens.

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