Friday, 20 February 2009

Investing In Entrepreneurs.

In this article, we talk to Charles Firmin-Didot, founder of the AXA Talents fund, with over USD400 million invested in entrepreneurs worldwide. We talk to Charles about entrepreneurship around the world, and why his fund invests in entrepreneurs.

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Vikas Shah, Thought Economics, February 19th 2009

Investors are now confronted with many ways to assess and analyse opportunities, from “quants” presenting their esoteric mathematical trading systems, to those using historic data to create business models, and many others using years of experience to create a “gut feel” for markets.

Looking at the last quarter century of our world’s business history, though, we have seen many individuals who would perhaps have slipped through the analyst’s nets and have gone on to create globally significant businesses. To name just a few of these from the public consciousness would reveal Apple, Google, Microsoft, Oracle, EasyJet, Virgin and more, with a vast number of ‘off radar’ businesses having been no less successful in their own rights.

These businesses have much in common, an innovative product or concept (which either created a market, or disrupted one), and a visionary leader who fought, “against the odds” to create value from an idea. In all these cases, too, we see businessmen who fought to take to market an idea which met with great resistance. Many investors failed to believe the numbers and buy into the concept which Larry & Sergei presented as their ‘Google’ concept, and similarly, many simply didn’t believe the business model could be possible which led to extremely low cost flights (EasyJet), a computer on every desk (Microsoft) and a step-change in how the world listens to music (Apple). The lucky few investors who got involved with these businesses, when interviewed later cite that rather than the “numbers and research” they were sold on the individuals behind the business, the “Entrepreneurs

In recent years, the concept of entrepreneurship has become much discussed, and pushed to the forefront of general consciousness as, through programmes like “Dragons Den”, and the explosion of online media, we are more aware that ‘entrepreneurship’ is within the general reach of man, rather than being the esoteric preserve of the gifted and rich (in fact, most of the most successful entrepreneurs in the UK, started from very humble beginnings, and rarely received ‘top flight’ education).

Charles Firmin-Didot is the founder and fund manager of the Axa-Talents fund, which follows a simple investment strategy: “we only invest in companies managed by visionary entrepreneurs.” In their own words, “Warren Buffett feels that many listed companies' CEOs are not motivated to take courageous decisions. Most CEOs are under pressure to manage their businesses for the short-term interests of the investors who prefer higher dividends and risk-free strategies. Research suggests when talented individuals are allowed to implement their long term visions in business, usually their performance is ahead of the market average. And that's why we believe in thinking long term is a good way to benefit future returns, and society in general. We always encourage talented CEOs to feel free to think long term and focus less on a few investors' short term interests.”

Charles joined AXA in 2003, bringing the Talents Fund with him. He has over twenty years of financial markets expertise, and has worked in asset management and M&A in Paris, London and New York for leading institutions. Charles is assisted by five other professionals specialised by region, responsible for spotting and following talented entrepreneurs. He lives between the United States and the UK, and also travels extensively in Asia to meet entrepreneurs. In this privileged interview, Charles tells us more about why he chooses to invest in entrepreneurs, what it takes to be an entrepreneur, and his views on global entrepreneurship.

>> Why Invest in Entrepreneurs?

[Charles Firmin-Didot] “The very simple answer is that they are usually better than ‘financial people’ like me at understanding businesses. What is a good product? What is a good opportunity? We have less of an idea than these people who have been in business all their lives and have their money tied up in their companies. This is exactly why we approach the situation in basics. We are less interested in business modelling , and realise that there is no reason we should be better analysts than the thousands of financial people out there, so rather than trusting ourselves, we trust entrepreneurs who are real value creators, have their own money at stake, with track record and no conflicts.

In my time, I have been lucky enough to have access to many entrepreneurs, it’s a fascinating world, and they are often very human with great contact…perhaps because they feel that we understand them, we respect their independence and would even protect it. The financial world, especially in the UK and USA has a “new definition” of corporate governance, where you have consultants saying “it’s bad when a company is controlled by one person or a family”. This is maybe the case where the person is a crook, but there are ways to check this. In practice, if a company is controlled by one person, that person (and their company) are more motivated than average, and because its their business, they tend to be more sustainable and, from our experience, think about the planet ten times more than their diffuse-ownership counterparts. We had, for example, one entrepreneur who sold his shipping business as he did not wan the risk of a potential oil spill when a tanker broke. We have another Spanish entrepreneur who took over his family construction company and has turned it around into a very successful alternative energy business focussed on the environment, a great story.

>> What is the scale of your fund? And what challenges have you faced recently?

[Charles Firmin-Didot] “Our funds have approximately USD400 million under management, and though, like everyone, we have had an impact in the last year or so, our performance, as a composite, still shows we have outperformed the market by 6% annually since inception. Last year was terrible; we had two very strong headwinds (which I will discuss).

It is important, though, to first look at how we define an entrepreneur. Most people think of entrepreneurs as start-up companies, who create value from nothing, but these can be, and often are, more established companies. Apple and Google, for example, are both ‘recent’ and huge companies.

The fact that we only invest in people who are big shareholders of their companies means the ‘float’ is limited, so the stocks are somewhat less liquid than average in the market. This is not true for companies like Google, but for the average $2bn market cap company, the entrepreneur would have, say a 50% holding, leaving, for example, after other things, a 35% float. We aim for long term holdings, and last year, fund managers were selling stocks that were not liquid (mainly due to redemption fears) and re-investing into liquid stocks. This had a real impact on our performance too (as it has a knock on effect on stock prices).

You can measure this phenomenon of float quite simply, by looking at holding companies which are listed (which often have listed subsidiaries). In the UK, we do not have many examples; Richard Branson had one [holding company] which was de-listed. By looking at these structures, though, you can calculate the discount to net asset value (NAV). The average discount:NAV in holding companies was 10% 18Months ago, and is now 45%. Why? Because holding companies are less liquid as usually that is where the entrepreneur has their stake.

To give you an example from France, we have a big retail chain called “Casino” which is one of the leading Global food retail groups (with 9800 stores, in 10 countries, and sales of EUR36 billion as at 2007). Casino is controlled 51% by “Rallye” (whose main asset is Casino). The owner of Rallye himself owns 60-70% of the firm, leaving a float of c30% (approximately 7x less liquid than Casino, even though it is the same business). If you look at the performance of Rallye versus Casino this is simpler to understand, the discount for the holding company went from 0% to 50% at the heights of the liquidity crisis last November.. It recently came back to a more reasonable discount. The second headwind is that entrepreneurs don’t care about short term profits. If you own and control a company, you think about the long-term and maximising value in 10years. You don’t mind that investing in research may reduce your earnings short term, and often don’t care about share prices daily (if it’s cheap, you can buy more). These firms often have low earnings visibility too rather than stable earnings, and at a time when people are nervous, they (investors) dumped companies with low visibility.

On the positive, in a recession, these companies tend to do well. Innovation, as Larry Page (Google) said is not cyclical, a new product will often sell because it’s new, regardless of a recession (e.g.: Iphone). Entrepreneurs have an inherent talent, whether its deal making, developing, innovating and more, all these talents can create value, regardless of the economic context.

>> How do you quantify investing in the “entrepreneur”?

[Charles Firmin-Didot] “Until a couple of years ago, when we started to engage more precise portfolio construction, there was no strict rule. The big question is, how do you combine the person and the valuation in a decision? We created a scoring system, putting a score on the person, a score on the valuation and a score on the catalyst(s) (e.g.: do they buy shares, have belief in their companies or are they running away!). We add all this up to 8 points on a person, 8 on valuation (including momentum, as P/E is meaningless if EPS is falling apart) and 4 on the catalyst (e.g.: insider transactions). We take these scores to rank our stocks.

How do we score people? A lot is based on track record, and a lot is based on their link with the company, their generosity to minority shareholders and any conflict of interest.

>> What, in your opinion, are the characteristics of an entrepreneur? And do you find any overwhelming similarities between them ?

[Charles Firmin-Didot] “Some of them were thrown out of school or didn’t necessarily have the best education. I will quote one of our entrepreneurs, Vincent Bollore (who is a big shareholder in Aegis in the UK), who said, “…if you are intelligent, there is no reason to be an entrepreneur, as intelligent people don’t want to receive punches from everywhere around them”. When you are entrepreneurial, you work a lot, you may feel independent but most important, you are passionate about building the future, and that is what often drives you, but you receive many punches all around. Also, entrepreneurs are people who are not afraid of taking risks, and not afraid of trying. They know exactly what they are doing, and something which, for us, could seem like a risk, for them, is not. In life, you have so many people with ideas, so few of whom try, and when you realise that trying is not necessarily a big cost or risk, and when you are ready to go for one of your ideas, that is when you get into the mind of an entrepreneur.

>> Are there any specific sectors which you are more invested in?

[Charles Firmin-Didot] “We try not to make direct sector-bets, and diversify as much as possible. In each sector we have invested in, though, we try to pick good entrepreneurs. For example, in energy, where oil prices collapsed, we picked entrepreneurs whose stock price fell, but their businesses are doing fine. They foresaw the fall, sold assets, and are now cash rich. They will, I am sure, buy their competitors. AKER (Norway) are a great example of this. We have also invested in alternative energy companies, because they got hammered in the market even though many are doing very well, and it is, of course, the main competitor to oil in the future. It is a very interesting sector.

>> What are your views on entrepreneurship in the BRIC economies, alongside African nations?

[Charles Firmin-Didot] “These countries have a lot of entrepreneurs.. The big difference in BRIC and other emerging economies versus established markets, is they are not about exploiting employees with low salaries, they are about innovation, and they sell globally. This is a very powerful force right now, especially with protectionism coming through (which will make any businesses that rely on cheap labour very exposed). We have an entrepreneur in China, who sells vegetables to Japan which is a great achievement, and we can’t forget emerging markets firms are buying up developed market assets such as United Breweries in India buying Scottish distillery Whyte & Mackay

>> Are any countries more conducive to generating entrepreneurs?

[Charles Firmin-Didot] “Entrepreneurship varies in different countries. Overall the credit crunch will not favour the creation of new entrepreneurs who need financing. I saw in the last few months many projects lacking the seed money to start. For the established ones, where they got there first, and have cash reserves, things are a lot easier.

If we look towards countries like Japan and Korea, where a company is held by a private person or family (more than 50%) the company has to pay more tax. This invariably leads to less competition in terms of numbers of entrepreneurs, and could therefore mean it’s easier to be a “better entrepreneur” relative to your competition.

In terms of “making it happen” for sure it is easier in the USA and EU. In China, you can only really progress if you have the right government links, and from our experience, in India, it is only easy if you are “born well”. This is changing, though, and we have now got a few successful first generation entrepreneurs, such as Bharti Airtel, for example.

Structuring is important too. In the UK, most entrepreneurs use the market to exit, and if they have a new idea, they will rarely put it in a listed company, instead doing it privately. Why? Because until recently, the tax structuring in the UK meant that there was no capital gains on selling stakes of existing businesses, meaning you could finance your new ideas, from selling existing, with no tax friction. The rules are changing, with more changes coming. In continental Europe, we have more capital gains tax, so for the entrepreneur, before putting innovation “outside” the business (where he will pay tax if he sells to finance the new idea) he will tend to put it inside the company, which changes investment strategy a lot. In Germany too, we see different habits, with many large companies staying private (of course, with exceptions like Porsche etc) this means that the firms not only stay private, but the innovations do too, and they often use the market to sell. In the USA, with their regulations, you get a good mix of both, but be wary of the limited protection of minority shareholders.

>> Looking at the future, what sectors and industries do you think will be the 'ones to watch'?

[Charles Firmin-Didot] “At the moment, a lot of entrepreneurs are looking at finance, thinking “I don’t want to get involved with that”. This is the message I’ve been putting to my investors since a year. People were looking at banks saying they looked cheap with high dividends, but it’s not finished. Many wise and older entrepreneurs think inflation is coming back big-time, and those with plenty of cash are getting worried about their physical-cash and are buying tangible assets, or companies which own tangible assets. Alternative energy is a big one to look at, sustainable and environmentally friendly businesses also. There are also many who are taking an optimistic view on commodities in the long term (ten year+). We also have an interesting entrepreneur in the US who runs “Overstock”, they are the market leaders in selling excess inventory, and the more companies that have problems selling, and the more they can get products at deep discount for their customers’ satisfaction. , it is very interesting times potentially good for business when you have cash, tangible assets and when you can be reactive”.


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It is clear, therefore, that entrepreneurs are quite unique in their character, combining unrelenting passion about their concepts, with drive, tenacity and the constant ability to innovate.

The latter quality, innovation, is perhaps the most powerful of these forces. Peter Drucker (regarded as one of the fathers of modern management) having been quoted as saying, “Innovation is the specific tool of entrepreneurs, the means by which they exploit change as an opportunity for a different business or a different service.” A sentiment mirrored, in context of modern business by Sabeer Bhatia, the founder of Hotmail, who said, “I think the soul of an entrepreneur is to keep trying until you find the successful idea.

Through my own work and businesses, I have been lucky enough to spend time with Entrepreneurs in many industries around the world. I have seen many bet their houses on ideas which have failed, and many which have gone on to create immense wealth from practically nothing. From conversations with these individuals, it became clear that while money was important, the underlying drive and passion came from wanting to try new things, to create value, to, for want of a better phrase, “be an entrepreneur”. Simon Woodruffe, a UK entrepreneur, and founder of “Yo! Sushi” sums this up perfectly saying, “Most entrepreneurs I know do it because they want to, not just to get rich.

For the world to succeed and for economies to grow, we need entrepreneurs, and we need people who are willing to take on the challenge to generate ideas and create wealth, not only for themselves, but for the wider community through the creation of jobs, and dependent or connected businesses (many, for example, have become millionaires, by becoming resellers of Microsoft’s and Google’s products and services).

Throughout history, entrepreneurs have also provided the philanthropic support to arts, music, medicine, science, and global issues of the time. Whilst Nietzsche opposed philanthropy on philosophical grounds (connecting it with the idea of the weak sponging off the strong), it is clear that the legacies left historically by the likes of Carnegie and Rockerfeller, and the multi-billion-dollar living legacies of Gates, Buffet et. Al, provide the financial muscle the world needs to create the next chapter of our history, and surely that, in itself, is a good enough reason to invest in entrepreneurs.


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For more information, please visit: AXA Talents Website


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