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Annual Mee ng 2016

An Evening with Mohnish Pabrai – Pabrai

Funds Annual Meeting 2016
November 14, 2016 by Chris — 1 Comment

Last month I had the pleasure of a ending the 2016 Pabrai Funds and Dhando Holdings
annual mee ng in Chicago. It turns out, this was the last Chicago mee ng that Mr. Pabrai
will be holding for his funds going forward. For those unfamiliar with Mohnish Pabrai, he
is the founder and CEO of Pabrai Funds, and currently manages roughly $400mm in
capital for individuals and ins tu ons. Mr. Pabrai adheres to a value investment

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 philosophy, whereas he has cloned Warren Buffe ’s techniques and has applied them
ever since he began inves ng 1994. Since then, Mr. Pabrai has had phenomenal returns
over the years. Recently, however, his funds have under-performed over the last five-year
stretch, which in Mohnish’s words, is an anomaly. Mohnish is very bullish on the future of
his funds, which we’ll get to later.

The evening consisted of a meet and greet, a presenta on by Mohnish, Q&A session,
followed by a cocktail hour and a dinner. There was a lot to gain from Mohnish’s insights
and views on his investments. Like Warren Buffe , Mohnish doesn’t typically discuss
individual stocks within his por olio at his mee ngs, but due to his recent five-year
under-performance, and significant por ons of his por olio being concentrated on a few
investments, he decided to give further explana ons into his reasoning behind his two
largest investments—Fiat Chrysler Automobiles (FCAU) and his investments in General
Motors warrants.

Mohnish’s presenta on focused on fund performance and fund outlook, peppered with
Fiat Chrysler commercials and topped with his views on the future of Pabrai Fund’s
investments. As men oned, the por olio is currently valued at ~$400 million, although
Mohnish’s believes the intrinsic value is $1 billion+ which will hopefully be reflected
within the next 2-3 years (note: current value of Fiat Chrysler and GM warrants within
the por olio are roughly half of the por olio, or $200 million). This represents 150%+
premium over the current value of its holdings.

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 Fiat Chrysler

The fund’s largest posi on is in Fiat Chrysler, represen ng ~28% of the por olio. The
investment has grown to be an outsized posi on within the por olio, which he believes
to con nue to be significantly undervalued.

The auto business is known to be brutally compe ve, where customers have a lot of
choices. American auto-makers are unionized and the industry requires high capital
expenditures. This isn’t the most conducive environment for a prosperous business.
Mohnish agrees with all of this points, in fact he even men oned he “hates the car
business”, however, he believes there is s ll opportunity in the space.

In 2012, Mohnish no ced a few investors who invested in the auto industry. David
Einhorn, founder of Greenlight Capital management and (most likely) Ted Weschler, one
of Berkshire Hathaway’s head investment managers, invested in General Motors.
Knowing them as very though ul investors, he decided to drill down into GM and the
auto industry, and while doing so, he came upon Fiat Chrysler.

The Company quickly caught his a en on, and he men oned it was one of the most
exci ng mes in his investment career, where he ended up reading up on the Company
and the industry for months and o en stayed up un l the wee hours of the night doing
so. The below was discussed during the presenta on, but mostly mirrors and quotes his

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 Q2 2016 investor le er where he was able to fully explain his thesis. Mohnish believes
the following (Mohnish’s words in italics):

1) Serio Marchionne (CEO of Fiat Chrysler) is a genius

Mohnish admits that he probably would have passed on the Company if it weren’t for
Serio Marchionne running the business

“If one had invested ~$1 million in Alusuisse when he became CEO in 1996 and then
kept moving those funds as Sergio moved, that $1 million would be worth north of
$30 million today. And that includes twelve of those twenty years spent in the lousy
car business – with zero prior experience in the auto industry. By 2019, when he
intends to hang up his boots and study Theore cal Phyusics (yes, that’s right!), that $1
million will likely have grown to over $100 million.”

“When Marchionne came to Fiat in 2004, it was on life support and almost bankrupt.
It had cycled through three chairmen, five CEOs and three heads of Fiat Auto in the
previous four years. He nursed it back to health and solid profits so that, in 2009,
when the much larger Chrysler was nearly liquidated by the US government and the
lights were about to be shut off in Detroit, he was there to pick up the pieces. And he
nego ated the purchase with no cash going from Fiat to Chrysler’s owners. If there is
a be er nego ator than Sergio on the planet, I am not aware of it.”

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 2) Fiat Chrysler has superior products and a strong brand

When Sergio took over in 2009, there were only 250,000 Jeeps sold in the world,
with the majority of them being sold in North America. In 2016, Jeep sales will reach
1.5 million, and is on pace to reach 2 million jeeps in 2018. The Jeep brand is
something to be reckoned with, and is a Fiat powerhouse.

“With its World War II legacy and seventy-five-year history, Jeep is an iconic global
brand. In China the term people use for SUVs is Jeep. Like Xerox, Fedex or Kleenex.
Products like the Wrangler have virtually zero compe on, Folks who aspire to own a
Wrangler see almost any other SUV inferior. FCS does not break it out, but I am sure
FCA nets over $4000 on average per Wrangler. And, on average every Jeep nets
them north of $2,500. The Chinese joint venture Jeeps are likely half of that. Let’s say
those are $1,000/Jeep. In 2018, the Jeep business alone will likely generate pre-tax
earnings of over $4 billion.”

“…RAM has wrestled market share from Ford and GM. Since 2009, RAM’s US market
share has doubled from 11% to 22%. Their Canadian performance is even be er –
going from 14% to 30%!

“RAM’s global volume is slated to be 620,000 units in 2018. They print money on
these with average profits of over $5000 per truck or commercial van. In addi on,
outside NAFTA, the Fiat commercial lineup does another 600,000 units a year.

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 “The North American light truck market delivers margins that are similar to
those of European luxury imports and this oligopolis c business deserves to be
valued along the lines of BMW, Audi, etc.”

3) Fiat owns three auto-parts companies that are extremely valuable

Fiat’s auto parts companies, Magen Marelli, Comau and Teksid, generate over $10
billion in sales. In the past, the parts businesses have had a measly 3% opera ng
margin. Despite these low margins, Fiat has already received offers north of $2.5
billion for these businesses. These margins are slowly inching upward, quarter a er
quarter. Sergio’s ul mate goal may be to gain more robust margins and subsequently
sell the businesses.

“There have been rumors that FCA has received offers for these businesses from
private equity firms for $2.7 billion. FCS is said to have rebuffed these offers as too
low. Marchionne has hinted that these businesses may eventually be sold. In 2015,
Marchionne named Pietro Gorlier as CEO of Marelli. Unlike other auto parts
companies, Marelli has had very low margins – less than 3%. Born in Turin, Italy, Pietro
is a ba le-tested Fiat execu ve. A er Pietro’s arrival, margins have begun an upward
trajectory and are now at 3.8%.

“Sergio is an operator. He has no desire to run a 4% opera ng margin business. I

suspect Pietro will work to raise these margins to 5% or more. A Marelli sale in 2-3

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 years may net the company something north of $4 billion. The en re market cap of
FCA is less than $8.5 billion. Marchionne has also wanted to hang on to Marelli for a
bit because of Masera , Alfa Romeo, etc. are leveraging their considerable
engineering exper se on some of their upcoming models.”

What’s it all worth?

“To be conserva ve, let’s ascribe zero value to the Fiat 500, Alfa Romeo and all various
other minor brands in the por olio. Here is the sum of the parts’ pretax cash flows in
2018.

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 On an a er-tax basis this is $7 billion. Sergio’s own guidance is for $5.2 to $6 billion. I
believe his numbers are conserva ve and will be revised upward. By 2018, the company
will have over $5 billion in net cash. If they have sold Marelli by then, they may have $9-
10 billion in net cash. If they do generate $7 billion ($5.40/share) in cash flow in 201, the
market cap will likely be north of $35 billion ($27/share). It is less than $8.5 billion today.
A business that generates $5-7 billion in cash flow is not going to change hands at $8
billion…

What if the shares are languishing at a P/E of 4 or less in 2018? FCA can also simply but
$2-3 billion every year into share buybacks in 2019 and beyond. The value accre on to
the remaining shareholders of such an ac on would be huge.

Because FCA started its journey with lots of debt and leverage, they have not been able
to capture the economics of having a fully cap ve global financing arm. These cap ve
finance arms, if run prudently, are amazing businesses. By the mid to late 20s, such a
cap ve financing business could be genera ng $1-2 billion in annual free cash flows at
FCA. These cash flows aren’t cyclical deserve a double digit mul ple. Alfa Romeo is also a
next decade story. Alfa could be worth billions by 2025. We are likely to either fully exit
or sell most of our stake in 2-3 years. There is a good chance that even at $27/share we
may have sold too early and le a lot of money on the table.”

The Potential Headwinds and The Changing Car Industry

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 The market has been worried about Fiat’s place in the “future” of cars i.e. electric and
driverless cars. Mohnish’s views are extensive on the ma er, but can be summed up fairly
quickly.

1. Electric cars

“Tesla makes awesome cars, but it is a nega ve opera ng margin business and requires
extremely high capex. Fiat does have an electric car and will also have a plug-in hybrid as
well. Once (if ever) Tesla is able to make money on a $35,000 Model 3, he will have a
close of it (with Italian flair and styling) in the market within a year. If Elon is successful
with Tesla, it will not be a threat for a long me. FCA makes money on Jeeps, RAMS and
minivans, and Tesla has no products that compete head to head with any of the main FCA
“cash gushers”. Electric cars won’t ruin the FCA investment thesis.”

2. Driverless Cars

Autonomous driving is not within Mohnish’ investment horizon therefore the

discussion is almost comical. If the world was 100% driverless tomorrow, what would
it look like? A family may need less cars, which would cut down a fleet of cars… but at
the same me the amount of total miles traveled by the US car fleet would skyrocket
because of the following.

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 If you summon a car to come get you to take you to work, these are incremental
miles that otherwise wouldn’t be driven.
Cost/mile of traveling will plummet.
Driverless cars mean more frequent road trips or one may live further away and be
able to afford in be er dwellings
More driving means less car life, meaning sales would rise significantly.

“The bo om line is that the total number of automobiles sold globally may rise
significantly in a driverless world. It won’t happen for 15+ years. Second it likely provides
tailwinds when it happens.”

3. Automobile sales have peaked (or the market believes so)

“The US car fleet has grown has grown in lock-step with the US popula on over me.
The bo om line is as long as the US and Europe muddle along, car sales aren’t going
to fall off a cliff. If we go into a recession, volumes will drop. How much they drop is
func on of how bad things get.

4. Recalls and product liability

“The auto manufacturers aren’t manufacturers anymore (that is why labor costs are so
low as a % of sales). They are assemblers. If there were to be a large liability stemming
from a vehicle defect, there is a decent chance FCA and GM could pass much of it

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 along to the part supplier…I am hopeful that any issues that arise are a small frac on
of cash flows.”

  5. Gas and commodity prices

The primary risk here is what if commodity prices rise? What happens when interest
rates rise? At some point both are bound to happen. There a few things to remember.

First – Yes, low gas prices have been a boon to the American people’s love of SUVs
and trucks. Don’t forget that there have been great strides in fuel economy. Higher
gas prices will cause some so ness in SUV sales, however this is somewhat mi gated
by fuel economy. Secondly, The significance of the change in the US oil reserves is
astounding. We now know that our oil reserves exceed those of Saudi Arabia and
Russia. This is a huge posi ve for the United States – in addi on to mankind. Because
of this, the odds of oil prices averaging $60/barrel over the next ten years is much
higher than the reverse. If oil prices to rise, auto sales will be par ally offset by fuel
economy.

“We will see reduced profits when commodity prices rise (again with a lage). Similar,
rising interest rates are a headwind for car sales. However, it is likely that both will
happen when the economy is crea ng a headwind for car sales. However, it is likely
that both will happen when the economy is crea ng more jobs and higher-paying
jobs. More prosperity means more car sales. Anything can happen, but it is hard to

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 see commodity prices and interest rates skyrocke ng before 2020 while job growth
stagnates.”

Question and Answer Session

The Q&A session was shorter than those I’ve read of in the past considering the length
and number of ques ons, largely due to the significant emphasis Mohnish put on his
presenta on and discussing their large posi ons at length. Below is a summary of the
Q&A session.

For your investment in Fiat Chrysler, what is your downside case?

It’s difficult to see a downside case to Fiat. Mohnish explained the primary assump ons
underlying the strong demand for several of Fiat’s key brands. You can refer to the latest
Fiat investor presenta ons for the assump ons on unit volumes through 2018. There has
been a secular shi from cars to SUV’s, so the big ques on is what can derail that trend
that Fiat is taking advantage of? The answer is very li le. Gas prices are highly unlikely to
derail this secular trend. It is very unlikely for sustained $70 per barrel oil in the near-
term, and increased fuel efficiency standards are con nuing to push the mark toward
larger vehicles.

Ford is investing heavily into technology and autonomous vehicles, what are your
thoughts on their initiative?

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 Sergio’s view is that GM and Ford are was ng money. The whole idea of autonomous
vehicles will be able to be replicated and serviced by the current suppliers, who are also
working toward similar goals. Furthermore, disrup on of transporta on won’t be un l
level 5 driving, which won’t be for 15-20 years (and maybe even more). It’s much be er
use of Sergio’s me and the Company’s me to focus on the current 5-year plan.

Given that you are discussion individual investments such as Fiat Chrysler and GM this
year, are you willing to discuss Aercap Holdings?

Save this one for another year.

Apple was an investment that Berkshire entered in this, why won’t Pabrai Fund’s invest
in Apple?

This is largely due to sizing considera ons. The Apple investment was most likely made by
Todd Combs, in Mohnish’s opinion, because it fits his style and is in line with some of his
other investments. Since Todd and Tedd, the two investment managers for Berkshire
Hathaway, manage $10 billion each, they are seeking investments in size of roughly $1
billion. This size considera on extremely diminishes the amount of investment
opportuni es out there for Berkshire, (and you can imagine what it’s like for Warren with
four mes the amount that Todd and Tedd have). If Todd and Tedd are inves ng $1 billion
into each investment and purchasing ~2.5% of a business, this assumes they are targe ng
businesses that are ~$40 billion in market capitaliza on.

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 Earlier in the meeting, you mentioned you are nding that many of the companies you
are looking at are either fairly valued or over-valued. Is it a good time to begin to
transition and hold cash?

The fund’s sold half of Ferrari, which looks expensive where it is currently trading at ~20x
earnings. Pabrai Fund’s isn’t holding the current market and currently is invested in what
he calla “quirky” businesses. Mohnish is thinking about selling certain holdings to boost
cash.

Is Dhando Holdings going to be directly buying any new businesses?

Mohnish has looked at poten al investment opportuni es, but in the current private
markets, mul ples are fairly healthy. There is a higher ROI in common equi es and other
areas. However, Pabrai funds will be opportunis c if the a great private business at the
right price comes by.

What is your vision for the Dhando Junoon ETF business?

The ETF business is a great business with wonderful economics once you are able to
scale. There is a commandment from Warren Buffe that says if you deliver above market
returns, investors will swim to you in shark infested waters. The Dhando Junoon ETF is
based on this premise. The Dhando Junoon ETF is set out to beat the market by a few

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 percentages per year. Over me, investors will recognize this and flock to the ETF. The
business will begin to scale once billions have been invested.

Filed Under: Uncategorized

Comments

Dhruv says
January 13, 2017 at 8:05 pm

Hi Chris,

I would like to extend thanks to you for sharing the valuable insights from
Mohnish.
I am an individual investor, perhaps too small to be able to meet the
requirements to invest in Pabrai fund. However i have been a silent spectator
and reader since a couple of years.
That being said, I am delighted to have found sleepy capital which i think is an
immensely useful pla orm for value investors.

I would like to Congratulate you and encourage you to keep up the good work.

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