Jeff Gramm  4:05  

The history of GM is just incredibly rich, right? To be able to tell the story of the rise of GM, then the decline of GM, and then the involvement of Perot… It gave me the opportunity to impart like a lot of business lessons and to use these extremely entertaining people like Ross Perot in the process of doing it.

Stig Brodersen  4:32  

I think that’s a good segue to my next question, because basically what we learn and how it should be is that managements are representing the shareholders interest, but as you point out multiple times in your book, you really reveal how hard it is to enforce this in practice. The management has multiple tactics to discourage takeovers from activist investors. 

Could you take us through some of the mechanisms about them? I’m specifically thinking about the poison pills and the greenmail that you mentioned a few times in your book, and perhaps also tell a story about how one of your activists in your book faced these challenges.

Jeff Gramm  5:13  

Sure, it’s interesting because with takeovers the management often loses their job, right? You have a situation where it is in the shareholders interest to sell the company. However, the management is strongly opposed to it. So, the two mechanisms that you brought up. 

There’s greenmail, which is essentially when the company buys out the activist investor. In the old days, Carl Icahn would come to your door, and he’ll say, “I own 9% of the company, and I’m going to push you into a sale process.”

What the company would often do, and in fact, like Icahn’s first 12 or so investments, I think that this happened over five times as they just bought out his particular stake at a big premium. So, the stock could be trading at $20 and the management and company would essentially say, “Hey, we’ll pay you $35 a share for your stake. Then, you go away.”

If you think about that, that’s incredibly unfair to the other shareholders. It’s like you’re basically taking the company’s cash to overpay for shares to entrench the management team. So, a greenmail is now… It’s not technically illegal, but it’s essentially been outlawed through changes in the tax rules, and also just the liability aspects of it.

The poison pill is still very much around. Now, the poison pill is a mechanism for preventing a shareholder from crossing a particular threshold of ownership. Lots of companies are going to be at 5%, 10%, 15% or 20%, where if a shareholder goes over to that threshold, if they cross 10%, then there’s a triggering event that causes a dilution of only that shareholder’s stake. It’s a very controversial thing. A lot of activists think that essentially it’s a legal mechanism that allows for what’s effectively a change in corporate law.

However, the poison pill is not always against the shareholders’ interest to have the poison pill in place. There’s actually a case that I talked about where I owned 30% of a public company, and the stock was extremely undervalued and I was continuing to buy. Then, the Board of Directors decided to put in a poison pill to prevent me from buying more shares as an activist in that stock. It was very frustrating because I wanted to buy them. Though at the same time, there was a very clear argument that keeping me from getting to 50% at a bargain price is in the shareholders interest. Now, I would argue that I’m a good guy, and if I get to 50%, I’m not going to screw people over. However, not all activist investors are like that.

Preston Pysh  8:20  

So Jeff, when you say that, in your example, you said if they get over 10%, then the shares get diluted, are you specifically talking about the dilution of the voting rights?

Jeff Gramm  8:30  

No. It’s the ownership rights. I mean, it depends. There’s a lot of ways to structure the poison pill, but now, the way they are typically structured is they’re called a rights agreement. If a shareholder crosses the threshold, so let’s use 10% as an example.

Say, I want to buy a public company, like I’m trying to buy into Target, and if they have a poison pill at 10%, if I accidentally crossed that 10%, and if I’m not paying attention, and I get to 11%, it triggers an issue of rights to buy more shares for everyone, except for me. Basically, I just get completely diluted, depending on the ratios in the rights agreement. It basically means that I can’t do it. If I crossed that 10%, it decreases the value of my stake. 

Preston Pysh  9:27  

Jeff, I’ve heard that you received a signed copy of your book from the one and only Warren Buffett. Buffett signed your book, correct me if I’m wrong on this. 

Tell us first tell us the story of getting this pleasant surprise, but also talk to us about the story you tell in the book about Warren Buffett and his unpopular way of dealing with the board at Coca Cola. There were a lot of people [who] were not happy with the way he dealt with the board, but it was a very elegant way, and I really liked the way that you described this in your book because I think you gave him a lot of credit where other people weren’t.

Jeff Gramm  10:02  

I just got it like a couple months ago, like I got to work and there was like that book in the mail. So he wrote a very nice note on the front. Then, he also put a note in the acknowledgments where I talked about him. 

I mean, it’s a funny story, actually. When I finished the book, I had sent him a copy and I remember as we were doing the pre-release, and I wanted to send one to Carol Loomis. I’m like a very big fan of hers and tried to track down her contact info through friends, but she had retired from Fortune, and I think I emailed her Fortune email and it bounced back. So, I just decided to email her Berkshire email that’s in the annual letter for questions at the annual meeting. 

So, I sent her this email that said, “Hey, I wrote this book. I’d love to send it to you.” I think that she checked email infrequently. So like a month or so later, I got this email from Carol Loomis, and it said, “Oh, I apologize about the slow reply. I just got email. I’ve actually already got your book because it was highly recommended to me by Warren Buffett.” 

Oh, my god! I mean, I was just like, the rest of the day I was on cloud nine. This was October before the release date in February, so I was just like, “Oh, man, I don’t have to do anything. If he likes it and talks about it, then people will find out about it.”

So, I got that email, and I just thought I’m home free. Buffett likes it. Then, nothing happened. Like he never talked about it. It didn’t get picked for Bookworm. Then, Carol actually asked a question about the book at the meeting the next year. Then, he’s been able to give a great answer, but he didn’t say, “Oh, that’s a good book.”  

Then, I began to question, well, if he actually liked this book. It’s interesting because when you put out a book, it sits around for a long time. There’s a lot of time to kind of think about the possibilities. I for sure thought, “Well, maybe he’ll talk about it in public, and I’ll get the Buffet bounce.” That never did happen, but the whole thing has been extremely fun.

Preston Pysh  11:59  

That’s awesome. I can only imagine how fun it would be to hear that somebody like Buffett endorses your book. Just so the audience knows, Jeff’s book is not just being endorsed by Buffett and Carol Loomis, you got Andrew Sorkin, who’s endorsed the book. You got Alan Greenspan who’s endorsed the book. You got Charles Schwab who’s endorsed your book so you got a lot of heavy hitters in your corner, my friend.

Jeff Gramm  12:45  

In a funny way those endorsements, they don’t actually move that many copies. So the key is just to get out there and to get the book out there, but let me tell you about the Coca Cola thing. I might have neglected the second half of your question.

Coca-Cola agreed to this compensation plan for its senior management that was pretty egregious in the eyes of shareholders. Like you saw, some shareholders get extremely angry about it, “We’ll vote against it and go public about it.” Buffett who had been on the board, his kid was on the board at the time. He was I think the largest *inaudible* shareholder, did not publicly oppose the plan. He just called the CEO and explained saying, “Hey, this is a little bit too aggressive on the compensation.” 

The following year, they replaced that plan. It never got enacted. 

Carl Icahn was extremely offended by that tactic. He basically feels like, “Look, we’re too nice to the management team.” If a guy like Buffett who’s like the biggest shareholder and was on the board a long time, so much of investing and being in business in general is about like your personality, you tailor your tactics to what you know will work with your personality. I just think that’s like the way that Buffet operates.

Stig Brodersen  14:16  

I think it’s an interesting point that you bring up about matching your personality with your investment style. I think there’s a reason why you have some people that are value investors and other people call them growth investors and whatnot. I remember Preston and I reading the books from…actually one of them was about Carl Icahn. I think that the name of the book was “King Icahn.” 

Then, we also read the T. Boone Picken’s book. I just remember reading through those books and it’s like, these two gentlemen must just be miserable like the way they approached other people and having you say that…You probably ride… Perhaps it was the only way for them to get to where they are today because that’s just how they handle things. That is what they’re consistent with. They probably couldn’t use Warren Buffett’s tactics, just like Warren Buffett couldn’t use their tactics, in terms of getting what they wanted.

Preston Pysh  15:05  

Well, what I really liked about how you presented it in the book, Jeff, was Buffett was able to get exactly what he wanted from the deal, but he went about in a much more indirect way. I think that it talks about his business finesse that so many people don’t have, because in the long run, when he wants to do something, again in the future, 5 or 10 years later, he’s going to still have that connection in place. He didn’t burn that bridge. 

He still has that connection in place to achieve what it is that he wants to do. Whereas so many people would have been short sighted or would have only been looking at something  in the short term in the way that they handled the situation and they would totally burn that bridge for future engagements later on. 

I really learned a lot from your book reading that specific section, because I remember when this Coca-Cola thing went down, in fact, I think Stig and I were out at the shareholders meeting when everybody was… I mean, they were beating them up that year over this question of…

Jeff Gramm  16:00  

There were lots of questions about that.

Preston Pysh  16:02  

Yeah, there were tons of questions. Why did you vote this way? During the meeting, you didn’t get a sense that he handled it appropriately, but the way you described it in the book and the way that you explained why he acted the way he did and what he actually achieved in the end, I’d never read that or seen that anywhere else. So, I really gained a lot of value out of that and your description in the book. It was very good.

Stig Brodersen  16:26  

My next question is also about Warren Buffett. I just want to put out there that Jeff’s book, there’s a lot of stories about different shareholder activists and specific approaches, but it probably comes as no surprise that the investor that Preston and I really focused on here would be Warren Buffett. 

However, back to the question, contrary to many other shareholder activists, when he bought into American Express, he didn’t ask for board seats or for the management to unlock dividends. His key concern was rather that those swindled in the so-called Salad Oil Scandal will be paid back full. So Jeff, could you please tell us a story about the Salad Oil Scandal and Warren Buffett’s special role?

Jeff Gramm  17:10  

Sure, sure. There’s also some historical context there, which I’m sure that like your listeners will know. Before the mid 1960s, Buffett was very much an activist investor like he bought these cigar butts and like would get on the board. He would advocate for change. It was a real turning point when he put a quarter of his fund in American Express, because it was just like a great franchise, and he thought that the management was mostly doing the right things.

Now, like the swindle is a pretty fascinating financial fraud. So at the time, American Express had their two core businesses. They had the charge card business that was new and growing and it had the traveler’s checks, which was like a fabulous business like a mature business, but you got some float out of it. It had like incredible returns, but they also had this thing called a field warehousing business. 

In that business, they would essentially guarantee the inventory of companies. So there is this company called Allied Crude Vegetable Oil. They would distribute soybean oil, because of the shadiness of the CEO. This guy, Tino de Angeles, who was like a known fraudster with connections to organized crime. They couldn’t even open a bank account, so they had a hard time with borrowing money, and so they used American Express to verify their inventory, so they could borrow against this [saying,] “You know, we are verified by American Express inventory.” 

The inventory was these huge big tanks in Bayonne, New Jersey that were supposed to be filled to the brim with soybean oil, but were actually filled with seawater. This guy Tino perpetrated this big scam, where American Express would essentially write him these receipts to verify the inventory. He would use those receipts to open brokerage accounts and to borrow cash. American Express had guaranteed over a billion pounds of soybean oil, more than existed in the whole country on paper. They were on the hook for a huge amount of money at the time. I think it was about $80 million that was potentially crippling to Amex. 

It was particularly damaging to the stock because at the time, it was like a joint stock company. It was well not a limited liability company. So, if you owned shares of American Express, and it turned out that they go bust and they have excess liabilities, then you as the shareholder of American Express could be assessed for those liabilities. All these well pension funds that *inaudible* American Express panicked and sold out. So it was a great buying opportunity for Buffett. The way that he saw it was, “Look. This is an incredible franchise. They made this big mistake. They’re going to pay for it, but the value is there and long term will [be a] compounding machine.” 

But what happened is a collection of shareholders decided to to get active with American Express and they said, “Well, the warehousing business was at a subsidiary of American Express, and you could file this thing for bankruptcy and not pay these liabilities and the shareholders would be better off.”

Buffett was extremely concerned about this and he wrote this letter to the chairman of American Express that was like, “I’m a very big shareholder. I bought this stake, well not because I thought that you would blow off these liabilities, but because of the long term value that I see in your franchise.” 

The claimants in this fraud were these huge financial institutions like the Bank of America. What Buffett saw [is] that if you hose all these claimants, it’s going to damage the American Express brand. So, he offered to testify in court that American Express; it was in their interest to pay these liabilities and that the activists in our shareholders were being extremely short sighted.

Stig Brodersen  21:45  

I really love this story and really tells you something about the development of Warren Buffett. You also mentioned that he started off as an activist and I guess this was also some sort of an activist play but something that Carl Icahn would do would be to like, see if he can take control because as an investor, you might have the idea that if you are in charge, you are the one who is making the best decisions. 

However, that was not his focus at all. That was basically just to make sure that reputation was intact, and then that the value of the company will be the driver or capitalist for it to reach its intrinsic value once again.

Jeff Gramm  22:23  

I mean, it’s a neat case because it’s clearly a turning point in his career. It’s the beginning of his transition to good franchises.

Stig Brodersen  22:34  

Jeff, I can’t help but think now we know how much Warren Buffett is *inaudible*, Carl Icahn, Ross Perot. They have millions if not billions of dollars behind them whenever they’re trying to influence management. What can the retail investor do to unlock shareholder value? Say that you only own 100 shares of a stock but still you’re not happy with the management, what do you do? 

Jeff Gramm  22:55  

That’s a very good question. I mean, in theory, there should not be complete disenfranchisement of the small investor. You can put out shareholder proposals. There are these big passive institutions that are thoughtful about them. If you have a good idea, in theory, they could support it.

In practice, that’s really not what happens. It’s incredibly rare that you see, essentially a retail investor having an impact on governance. The one that pops to mind for me is there was a shareholder in Virginia Dominion Power, who was, I think…she was a NASA engineer. She did a shareholder proposal about sustainable energy practices at the company, and it got broad support from the big institutions. I think to the tune of over $10 billion of market value. However, that was very much the exception.

I think that dirty truth is that corporate America is increasingly controlled by a very concentrated investor base. It was extremely concentrated and like in the 20s, it diffused into the 1950s. However, in the beginning in the 60s, it began to reconcentrate, and that has only continued to happen. Therefore, it’s incredibly hard for a retail investor to do anything about a company where they think that the governance is bad. 

I mean, if you are a shareholder of a company and you’re extremely displeased with the decisions that they’re making, your best bet to intervene is to call the big shareholders and to try to get them on the phone and to make your case. But if that doesn’t work, then I think that you have to consider selling you which is very tragic. 

Preston Pysh  24:56  

For people that are listening to the show that might not know this. So Jeff came to our live event that we had in New York City. He was on the panel with us; with Toby Carlisle and Wes Gray. One of the things that came out during the panel discussion was that Jeff’s fund that he runs is a very focused portfolio. So, he doesn’t have a lot of picks in his portfolio, very similar to the way that Buffett has invested through the years as he has a very focused number of companies that he selects. 

So Jeff, I’ve got a hard question for you. When I look at a guy like Bill Ackman, who implements this Buffet-style approach, who has a very focused portfolio. He had just a terrible [year]… last year. I mean, it was a disaster. When you think about that, and you see guys like Ackman go down and just have a horrific year, alot of people say that that’s because they had such a focused portfolio, and they didn’t have a lot of stocks. 

We had a discussion with Guy Spier very early on when we did our podcast. The one thing that we asked Guy was what he learned in the 2008 Crash. Guy said, “I was way too focused in only a couple companies, and I paid the price for that.” 

How do you feel when you see guys like this? What are your thoughts and opinions on that? Why do you think that that’s a better approach for you personally? I’m just kind of curious to hear your thoughts on it.

Jeff Gramm  26:14  

I do think it goes back to that thing we were talking about with the dispositional will fit, like a view and your strategy. Just like the way that I invest, I’m extremely focused on downside risk. I look for the rare situations where I think I’m completely protected on the downside. I’m not always correct about that, but it’s just been the way that work for me is to have 10 or 15 positions that I can completely be on top of.

However, you’re completely right, like the concentration is incredibly dangerous. Buffett is kind of the exception that proves the rule that it’s like incredibly hard to do it over a long career, because it’s too easy to blow yourself up. I think the main danger is with value investing. So much about avoiding the big mistakes, keeping sane…

The problem with concentration is when you have a super big position in your portfolio, it’s easy to get emotional about it. It’s easier to be attached to it. It’s easier to have confirmation bias. So sure, the return can be magnified if you’re right. That’s like what everyone thinks about. However, all the psychological forces against you are magnified if you have a 20% net position in one stock. That’s extremely dangerous.

Preston Pysh  27:46  

Jeff, I got a question for you because I’ve thought a lot about this. Do you find that businesses that have an individual specifically a founder that retains a very large chunk of the voting rights of the business have a tendency to perform better moving forward than something that has the ownership rights just spread out to low levels like 1% or less? 

Do you find that those types of businesses do better when you have that person that’s still kind of steering the ship, and saying, “Hey, this is the direction the business needs to go?” 

They’ve got that sense of what the customer wants. They understand competitive advantage and all this stuff. They’re not just trying to keep the shareholders, the employees, and the customers happy all at the same time. 

Like I find that when you see a business that has a very focused control of equity, specifically with a founder, they seem to be much more customer and employee-focused and don’t really care too much about the shareholders, which I think in the end actually takes care of the shareholders better than when a person tries to balance all three of those.

Jeff Gramm  28:52  

I think that’s a fascinating question, and I haven’t looked at it in a scientific way. Pocket of the market that I focus on, which is very small companies like the micro-cap world, well, more often than not, the founder-controlled companies are problematic. They’re often vehicles for self-dealing.

I think if you look at bonanza outcomes like the very successful that you do see lots of these founder-run companies, but I think there are fewer of those out there…[than] what people think, and there are lots of classic founders who took their companies public, and then began to milk it for their own benefit.

Stig Brodersen  29:38  

So, this part of the show, Jeff, [where] we would like to ask you what your favorite book recommendation is? I’m really excited to ask this question of you since you have a value investing background.

Jeff Gramm  29:50  

Sure, I really loved Joel Greenblatt’s “You Can Be a Stock Market Genius.” It came at a time in my life where I didn’t know a lot about investing. Sure, it taught me about the spin offs and the restructurings, the so-called hiding places in the market that he talks about.

However, it gives you this mindset that there are bargains out there. That book is incredibly good at debunking the idea of efficient markets like without requiring a whole lot of discussion on that. Then, expressing kind of the treasure-hunter mindset of buying a $.50. 

I’ve read lots of investment books, and it’s hard to convey those lessons. Also, I think that Joel Greenblatt did that extremely well with that book. I think it holds up still.

Preston Pysh  30:46  

So this is hilarious because even the title of the book, we’re used to saying the title, so we think that it’s normal that the book’s title is “You Can Be a Stock Market Genius.” So I’m in my house and I’ve got these library shelves of all the books that I’ve read, and I’m trying to find this specific book because I’m trying to look something up that’s in that book. 

Then, I asked my wife, I said, “Hey, can you help me find a book?” And she said, “Yeah, what’s the title of it?” I tell my wife, “You Can Be a Stock Market Genius.” And she literally looked at me and just burst out laughing. She goes, “What’s the actual name of the book?” She didn’t even believe that that was the title of the book.

Jeff Gramm  31:25  

Well, that’s like the paperback title. Do you know the original title? It’s “You Can Be a Stock Market Genius Even If You’re Not That Smart.”

Stig Brodersen  31:37  

Oh, my God.

Preston Pysh  31:41  

Oh, my gosh. Well, you can’t argue with the facts and the facts is that that’s a phenomenal book. I mean, if anybody listening to this hasn’t read that one, man, you’re missing out. 

Okay, Jeff. We want people to know where they can find you. Tell them your Twitter handle. Tell them the name of your book and where they can find it. Let them know where they can learn more about you.

Jeff Gramm  32:01  

Sure. The book is called “Dear Chairman: Of Boardroom Battles and the Rise of Shareholder Activism.” I’m doing a lot of events in the coming year. I’m going to London. I’m going to Australia. I’m doing a lot in the US. I’m on Twitter, @Jeff_Gramm. I think I met you guys through Twitter. So, it adds value.

Preston Pysh  32:23  

You absolutely did. In fact, one of our one of our followers on Twitter said you got to read this book. It’s fabulous, and that’s how we got hooked up. 

So, Jeff, such a pleasure having you on the show. We really valued all your input and really enjoyed your book. Thank you for taking time out of your day to come on The Investor’s Podcast.

Jeff Gramm  32:43  

Sure. Well, thank you so much for having me.

Stig Brodersen  32:45  

All right, guys. That was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Outro  32:52  

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