#68 - Andrew Sheiner: Private Equity, Selectivity, Discipline

32:33And they can make great micro calls, but get wiped out by the macro. And so I guess part of what you're describing is just an appreciation of that and recognizing that the macro is very difficult to predict. And you want to have much greater predictability with your selection of companies to invest in. For sure. I think I'm fortunate to have been at this for a long time. Right. Having started in 1995, I've had the good fortune to have looked at lots of businesses, acquired and invested in a significant number. And there's muscle memory, in a sense, with this business. So you're constantly refining that understanding of durability, risk.

33:27And for us, you're absolutely right that the macro overlay is something that we have to be mindful of. Always understanding we're investing in a dedicated, unique business. We have to be very mindful of the macro overlay. And given that we're not looking to find 10 or 15 businesses a year, but one or two, in 2018, we bought three. The bar is very high for us. But because we don't have the pressure of having to deploy capital, of having to buy a large number, it allows us to take the time to think about these things. and to try to be mindful of the various forces at play that can impact these businesses that perhaps are lower probability.

34:25You obviously take a very highly selective approach to private equity, acquiring only one or two companies per year. Many of your peers tend to have broader diversification. What are the advantages of this concentrated strategy and why do you believe it's a better approach for Altus and having a more diversified approach? Most fundamentally, I just don't think over the long term we will perform as well if we try to buy five companies a year. The likelihood of us finding a larger number of businesses that fit our framework and where we have equally high conviction, I think is just very low. And so I think we will be well served to continue to remain selective and disciplined.

35:14And my view is that if we can generate mid-teens or better, which is what we set out to do, and then we work hard to exceed that, over the long term, and we can keep impairments low and our loss ratio low, then we're delivering on our end of the bargain. We see our job, Alex is investing a dollar and turning that into two, three, four, five dollars time and time again, and limiting the number of times that there's an impairment of capital. And for us, the way to do that isn't to buy a lot of companies, because I think then you end up with inevitably a portfolio whose returns are somewhere around, you know, centered around the mean, right?

36:04Or, or, or the median in the industry. If we want to do better than that, I think being more disciplined and more selective will serve us well. And, and that has been our approach when we started and we were five people and it's approached today. And now we're 75 people still looking for this small number of businesses each year. And the other thing that I think our investors understand is that they are well diversified. Many of our investors would be invested with 20 managers. If you look through the funds, down to the line items of the individual companies, they own a lot of businesses. And so I've always believed that they don't need us for more diversification.

36:50They're well diversified. We are in the rifle shop business. and we're in the business of finding one company at a time small number each year where over time we'll build a portfolio of businesses where we have very high conviction we think can collectively generate returns that achieve our objective because our objective is to generate strong private equity returns with the least amount of risk and private equity returns need to exceed the public markets over the long term. Otherwise, you shouldn't do it. Because we're giving up liquidity, and liquidity is very precious. So if we're going to give up liquidity as an investor and owner of a company, my goodness, we better achieve better returns.

37:36Otherwise, nobody should give us their capital. So understanding what that objective was, and the strategy flowed from the objective. So that's how I think about it. And how do you manage risk with a concentrated portfolio, especially given the potential impact of one bad investment on the entire fund? We manage that risk by being incredibly careful around the nature of the businesses that we acquire. And today, by putting six, seven, or eight businesses in a portfolio where we think the risk of losing all of our capital in any one of those is extraordinarily remote. We can withstand a body blow, an unexpected body blow in our portfolio.

38:34But when I look at the combination of businesses that we're acquiring, the likelihood of some number of them taken together, being impaired to cause the return on the entire portfolio to be poor is very, very low. So I suppose one way to create diversification is to have a bunch of holdings. Another way is to have fewer holdings, but each of those have different sensitivities to different factors, and you can diversify by those, especially if they're not all economically sensitive. Then you can effectively have sufficient diversification with fewer number of holdings that are higher conviction.

39:20is exactly right because we're not we don't invest in one sector right so our businesses aren't subject to the same economic forces to the same risks because each one is independent and subject to the forces that are impacting their unique subsectors the interesting thing is there are many similarities between our businesses from an attribute perspective characteristically. We know what we like in terms of the nature of the machine, using the analogy that a business is a machine that generates cash flow. However, each machine is different, right? And the ecosystem that they're involved with are different and the forces that impact them are different.

40:09So to your point, they're each subject to different macro considerations. And that form of diversification is what gives me comfort to invest in this manner. What are the key ways you add value post-acquisition and help portfolio companies create long-term value? So I think that's one of the genuinely interesting things about the way we're able to invest as compared to investing in a widely held public company, which is that we're looking to invest in businesses where we have the responsibility of ownership, the responsibility of governing these businesses. And we buy businesses where we have a clear perspective and thesis on what is required to be put in place to take this wonderful enterprise and take it to the next level.

41:25and philosophically our view is that the most important decision that we make and it's our responsibility is who the ceo will be that will run this business because we're you know in venture capital they often talk about backing a team in a sense we're not backing a team we're buying a business that has real capabilities that we can underwrite and assess. And then the most important job is who the CEO will be that runs this company. Often the CEO is in place, but from time to time will acquire a business where the plan is to either elevate somebody to that job or bring somebody new in. And that's the most important decision because they're going to be running the business day to day.

42:12And we need to understand that. With that CEO, we then need to align on the vision for the business so that we're very clear together on where we want to take it. And with that understood, Alex, we then are focused with the CEO on three things. right what are the key priorities from one year to the next that we want and the co agrees it's important for the the senior leadership to need to focus on over the course of the next 12 months and those are going to evolve over time so what are the key priorities and then they're going to cascade priorities throughout the organization what are the capabilities that are required to execute on those priorities?

43:01And I'll come back to capabilities in a moment. And then lastly, who are the people that we need within the organization to achieve all of that? Of those three, in many respects, I believe the most important is the team, the talent agenda. Because if we get the right team in place, then we're going to land on the right priorities and we're going to put the capabilities in place. to execute on all of that. If we have the wrong team, we're going to sub-optimize for sure. So where we're very focused is on the question of what capabilities are required. And those can be built internally. Those can be brought to bear externally.

43:48Or we can deliver those capabilities at our firm. And we have built over the course of the last many years a group at Altus, which we refer to as PSG, which is not a very famous French soccer team. It's our portfolio solutions group. And that team is focused on working with our management teams on very important key needle-moving initiatives that can really make a big difference at the company. And we built a team that sort of knows how to do that well. And we are extraordinarily focused with our businesses on the effort to upgrade their executive teams to give us the best chance of accelerating the development of the company.

44:42So our head of talent at Altus is a woman. Her name is Lisa Diamond. and she started her career as an organizational assessment effectiveness consultant at BCG, ended up running all of BCG's talent enterprise at BCG Canada and joined us to both focus on the talent at our team, but very much to be focused with our CEOs and the heads of talent of our companies on the talent agenda at our businesses. So our philosophy is let's put the various key pieces in place at the businesses. Let's add value on the talent side and on key capabilities and then make sure we're well aligned. And the other thing that's important is it goes back to one of your very first questions, which is why I always found this job interesting.

45:39which is that the decisions that we make on who the leaders will be these businesses are critically important because we need to develop effective and trusting relationships with them and what i often explain to young people is that yes while we control these businesses from a practical standpoint we are in the moral suasion business right we're in the business of having to develop these trusted relationships so that we can align on what we're trying to accomplish. It's no different than a sports team, right? You know, it starts with the owner, down to the GM, down to the president, the coach and the players.

46:17Let's all get aligned. We're the team owner in many respects. If you look across sports, there's some great owners, there's some less good owners and teams that have great owners tend to do well over time and teams that, you know, have bad owners, they make bad decisions. and you end up with bad outcomes. So that's the analogy for how I think about this. And it's one of the things that makes the job interesting. The last thing I'd say is, one of the things that we've worked hard to be good at is to really be able to assess what is required to really take these businesses to the next level. around people, systems, processes, capabilities, which is different for each company.

47:09And then how effectively and at what pace can we put those in place to really start to see outcomes? Because the businesses that we buy, we buy them not to simply hold them for two years, but four or five, six, seven years, because it takes time to really grow the operating income of these companies, which ultimately is the surest way to create equity value. And I guess going back to how we began our conversation, if you're trying to help these companies solve the puzzle to take it to the next level, you have to make sure they have all the right pieces to solve that puzzle. Right. My mental math is very simple.

47:53We buy these businesses where we have conviction that there's an opportunity to grow their EBIT. And the way to generate financial returns in our business is to do two things. One, we want to grow operating income well above the rate of inflation organically. And then we look for businesses, Alex, because we're very focused. We typically buy services companies. They're not terribly capital intensive. They tend to be highly cash flow generative. And we're interested also in businesses that not only generate strong cash flow, but have the ability to reinvest that cash flow on an ongoing basis at an attractive unlevered rate of return.

48:49And if we can do that, very powerful way to grow equity value. So we're looking to grow operating income and to enhance that rate of growth organically, well above the rate of inflation, and then to be able to hopefully have the opportunity to reinvest cash flow inorganically in an attractive rate of return. And it's very important to us that our management teams understand that and understand what we're trying to accomplish. We're very aligned with that. And then we set about enhancing team, people, system processes. but it's all in the service of that objective, right? How do we take this machine that's been built, it's a wonderful, durable machine, but we need to have a conviction that there's levers that we can pull either because it's not being optimized or it's underperforming relative to its potential that can allow us to accelerate that and drive operating income organically and inorganically.

49:45And that's ultimately how you're able to make money over time and generate strong returns over time in this activity, in my view. What are the types of things that can go wrong with the approach? You're saying with a particular company? Just in terms of when you're thinking about investing in these companies and adding value, what types of things can derail that success that either is unpredictable or maybe it's bad underwriting or what are the types of things? Sure. So one of the big areas of risk and uncertainty these days that we are determined to hopefully get right, but it certainly is an area where things can go wrong, is around how technology can disintermediate a business that has had a durable history, right, based on how it's been built and how its ecosystem has operated to this point.

51:07And certainly with the advent of generative AI,

51:16industries are going to be disrupted. And so it is incredibly important for us when we look at a company to be thoughtful around the question of whether that capability, this emerging technology, for lack of a better term will be something that enables the company or imposes risk on it. And we're very lucky we have in our orbit and on our advisory board an old friend you may know named David Lowey, who was early a team member at Google, ran a lot of marketing for Google-led business development for many years and then left around the same time we founded the firm to create something called Capital.

52:09We were originally Google Capital and then Capital G, which is Google's sort of growth equity investing arm. Retired last year and is spending a fascinating year just learning about AI at Stanford. And David is in our orbit. So whenever we look at a business and there's this question, you know, we're spending time with him and people in his world asking ourselves this question about whether AI will pose a threat for the company in this business or will enable it and allow us to, in fact, grow it. You could get that wrong, for sure. But it's something we're very focused on trying to get right. I think of that as an area of risk these days when we're looking at a business.

52:58The way we try to mitigate these types of things after we own a company, which we've made the decision, is we believe in the importance of trying to return capital along the way as a way to de-risk our investments. Back to the earlier conversation, we own a small number. It is not uncommon for us two or three years in, and we've done this three or four times now, where we have sold 25 or 30 % of the company and returned 50 % or 100 % or more of the capital. And some of our investors said, well, why did you do that? You're giving away a bunch of upside. And my view is if I can sell 30 % and return more than 100 % of our basis, I will do that all day long.

53:45Back to my natural state of paranoia. We did a homework project in education that led us unexpectedly to ultimately have the opportunity to acquire the leading international medical school in the world. A remarkable business that I didn't know existed. We did several years in this subsector that had been built from 1 to 115 of EBIT in 38 years. And we were very fortunate to take it from 115 to 240 with a new team we put in place over six years. But along the way, again, we sold a 30 % stake to another private equity firm that allowed us to return. I think it was two times our capital. It kept 70 % and continued to build it.

54:28We've done that with our insurance brokerage company. It's one of the things that we like to do as a way to mitigate risk. Because to your point, there are known risks. There's unknown risks. And if we can reduce those, the best way to reduce risk is to return everybody their money. The best way. Then the risk of capital loss is removed. Hope that's helpful. Private companies, especially successful ones, oftentimes have a choice of PE firms to partner with. How does your long-term orientation position you as an owner of choice for private companies? Let me describe how I think about Time Horizon, which is that we're buying businesses not to simply own for one or two years.

55:21And that's because we buy businesses to really take their operating income to a different level that takes time. From a practical standpoint, I think we will own most businesses for four or five, six, seven years. And that's because we buy them. We have a clear thesis. we set out to execute on a plan, the orientation in a sense, Alex, is long-term because we're looking to build these into more durable, more valuable businesses that can be built for the long-term. Our part of the journey will typically, in my mind, be four, five, six, seven years. That said, when we set out on this journey, my hope was that if we're lucky, once or perhaps twice a decade we might find ourselves owning a remarkable business that is sort of the gift that keeps on giving where the first chapter leads to a second chapter and could lead to a third chapter and we might own it longer which would be wonderful and we want to have that orientation and the flexibility to do that but we understand that those are very few and far between understanding that most businesses we're going to have a thesis and that second chapter may not emerge or somebody may come along.

56:41You know, one of our businesses in the first few years, a strategic came along and offered what we thought was a very high price that allowed us to pull forward several years of work. Or where we think that the industry landscape is changing, you know, a bit of our job is to look down the road and around the corner. And you have to be willing, as willing to sell things as to hold them. Every year, beginning of the second year, we do this thorough re-underwriting of each business. Because a decision to hold it is, as it is often said, a reinvestment decision. So it's going to be rare that we own a company longer.

57:26To answer your question, if somebody's just interested in the highest price, they don't care about who the next owner is, we're typically not the right partner. But if there's a stakeholder that cares, a management team, a shareholder that's going to continue to own an interest in the business, and they're looking for an owner or a partner or investor that can add value and has this orientation of really meaningfully building a business, and that's what they care about when they pass the baton, we're a good choice. because also we don't own 50 companies you know today we own eight and uh each one is like a child which means you care you know we're caring we care about them we're nurturing them you know the you know we're carefully feeding and watering them and so you know because that involvement is a little different uh we're often attracted its owners and management teams that are interested in that type of engagement that attracted to us.

58:37You discussed investing in CEOs. Are there any qualities of great leaders that are counterintuitive or broadly underappreciated? So I don't know if these are underappreciated, but I think great CEOs are ones that can articulate a very clear vision to their teams and throughout their organizations are great judges of character, right? Because businesses are built and run by teams of people, not by single individuals. So if a CO is a great judge of character, can express clear vision that they can articulate, and that can inspire trust and confidence, that in my view consistently is what makes a wonderful leader and the ability to both inspire trust and confidence in your team and also hold them accountable at the same time is difficult and hugely valuable and i think of you know mark cone who's the ceo of Hub International.

59:53He started as an insurance broker in an office 30 years ago. And he is as detail-oriented as anyone I've ever met as a CEO, which means that he really understands every element of the business and can hold his team accountable. But he also has the ability to inspire them based on a clear vision for where the business is going and what they're trying to accomplish. that dual ability, right, to be detail-oriented in a way that allows you to hold people accountable because you really know the business and at the same time be able to inspire them and to develop trusting relationships, I think is, you know, an element of traits or a combination of traits that I often see in great CEOs.

1:01:02Conversely, are there characteristics of great leaders that are often viewed as important that you don't value as much? Probably presence. Oftentimes, people think of CEOs as the leading man in a Western movie. I don't think that presence is anywhere near as important as knowledge and thoughtfulness. And I've worked with CEOs that are quite soft-spoken but are still remarkably talented CEOs. they can be even keeled and soft spoken but because they engender trust and confidence they can be very effective so that's probably one attribute that people may overestimate you know the ability to walk into a room and command a room less necessary I'd say not unnecessary but less necessary you've demonstrated a strong commitment to giving back, particularly through your efforts to educate and mentor the next generation of leaders.

1:02:25Would you share what motivates this passion and how you hope programs like Wolf Scholars will make an impact? The Wolf Scholars Program is a program that was named after my grandfather, my late maternal grandfather, Wolf Cooper, who came to this country as an immigrant and was incredibly grateful for what North America could offer and for the system that had been built. And because he fled Europe after the Second World War, having survived the war, he had a great appreciation for the value of a free society and liberal democratic system. And the program, which we've established in partnership with the University of Toronto, is really focused on creating a generation of innovators, builders, and leaders in Canada.

1:03:30And I live in Canada. Our firm, we operate from Toronto no different than if we're in Boston, New York, or San Francisco, and we have an office in New York, but home for me is Toronto. And so many young college, high school seniors these days feel immense pressure to go to study commerce in undergrad, certainly in Canada, as a way to hopefully create a path to an interesting job. and I think that we'll be better served to train kids that have a bit of a more multidisciplinary approach to thinking about the world and that can learn how to be critical thinkers and thoughtful problem solvers. And for that, I'd like them to have the opportunity to learn about history, how the world has evolved over time, to be exposed to leaders in business and otherwise.

1:04:30In an era where critical thinking isn't as valued as perhaps it has been in times past, and so we've created this program that is determined to hopefully train a generation of young people that will tackle the opportunities facing their generation with both a multidisciplinary understanding of the world, an appreciation for history, and a framework that will allow them to tackle problems thoughtfully. And this is something that's been in the works for many years that we actually just launched a few weeks ago that will be fun to build. And I like building stuff. I've enjoyed building the firm and I'm excited to build this and hopefully, you know, we'll wake up 20 years from now and have graduated some pretty interesting leaders.

1:05:35We'll see. That's great. So, Andrew, I have good news for you. You have been appointed private equity king for a day. And the power that you have is you can change one thing about the private equity industry. What would that be and why? Thank you for the appointment. So one day, it would be fantastic, Alex, if investors would have the ability to invest in and out of private equity portfolios in an easy way at NAV. so that for folks like us, we wouldn't have to spend a massive amount of time every three or four years trying to raise the next fund. It is a, it's part of my job, right? So every few years we have to go raise a pool of capital that provides us with committed capital for us to then go invest.

1:06:48And I don't know if we'll get there. But if we could simply go about our job of buying businesses at the right time, selling them, reinvesting that capital without having every few years to take this detour, in a sense, to have to go, you know, raise a whole bunch of capital to do it again. And that would certainly free up a whole bunch of energy and time to allow us to simply do our job of researching industries, underwriting businesses, and owning them. For that to happen, the industry needs to create a mechanism to give investors confidence that they can invest in and then get liquidity from in a reasonable time frame and at net asset value, their interest in those portfolios.

1:07:49If you can buy into and get out of a portfolio of private equity at NAV and you could trust that and trust that when you want your money back within reason, you can get it, that would be fantastic for this industry. It hasn't really been created. I can leave that to you to figure out. If folks could figure that out, it would certainly make my life a lot easier because I could focus on doing my job well. So that would be great for this industry. I don't know if we'll ever get there. I know people are thinking about it, sort of beyond my pay grade, but that would be super interesting. Well, Andrew, I've had a lot of fun with this conversation.

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