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Fund Manager Focus - December 2009

David Baverez, KDA Capital - London

French and Italian fund managers make up a disproportionate part of the hedge fund community in London, where a certain kind of Latin agility is in demand. Not all hedge funds, however, follow exotic, short-term, strategies. KDA Capital, founded by David Baverez, is a long-only, long term fund that invests in turnaround stories.

After graduation from HEC followed by an MBA at INSEAD in Fontainebleau, David Baverez started his career at Fidelity Investments in London 15 years ago. He spent 10 years with Fidelity, first as a sector analyst then as a portfolio manager of various funds, mostly invested in European equities. He created KDA Capital in December 2005.

How would you describe KDA Capital and its investment strategy?

“Our firm manages about $350 million in European equities, mostly for US and European institutional accounts. We follow a simple strategy. We invest into situations of change that the market has not seen or properly quantified.”

How is the team organized?

“As Managing Partner, I manage the fund with the help of four sector analysts: one following consumer goods, one financials, one cyclicals and the last one specialized in several fields: real estate, medical technology and Scandinavia. We do not cover pharma and technology because these fields are too complex and too specialized. ”

How would you describe your investment process?

“At KDA Capital we attempt to exploit the lags in the perception of change by the markets. Change comes in four guises: industry change (outside the company), management change (inside the company), change of perception by investors either of the sector or company, and finally change in valuation techniques applied by sell-side analysts to a company or sector.”

Can you give us an example of the type of situation you invest in?

“For us, an ideal situation is a company where the sector has seen structural disruption, but management have not adapted, resulting in a profit warning, for example. As a result, investors turn away from the company and the sell-side come to value it through shorter-term metrics such as cash flow yield or dividend yield. This ultimately triggers a reaction. New management is appointed, restructuring occurs, and investor confidence progressively returns.

Finally, analysts switch back to valuation techniques focused on medium to long term elements. While they had come to look only at metrics like free cash flow or dividend yield, they gradually move to more standard measures like P/E, EV/EBITDA and ultimately EV/turnover. Although the cash flows have not changed, the multiples used by the analysts are different and so is their price target.”

Is this a value investment strategy?

“No, it is wider than that as this situation can happen to companies with a value or growth story. For instance, if a company’s top-line growth suddenly goes from 15% to 5% but it still has a P/E of 15, that is not necessarily acceptable to a value investor, however we could be interested because we think the situation could be temporary. ”

How do you identify these particular situations?

“To select stocks, we follow a thematic approach. We spend a lot of time looking at changes happening in the market under the pressure of demographics, consumer behavior, and technological disruption. When we have identified these new trends, we try to find the best way to play them. We track companies that suffer from these changes and yet, after some adaptation, will also profit from them. We have a turnaround strategy.”

Do you see many opportunities at the moment?

“Yes because there is a lot of change in the way governments, consumers and companies behave. That creates lots of opportunities for our strategy.

  1. First theme: “ heavy government”
  2. We are moving from a period of “light government” to an era of “heavy government”. Governments are spending a lot of money to prop up the economy. So who profits from it? We want to avoid the obvious sectors like infrastructure. Bouygues, for instance, tells us the effects of stimulus packages are only going to materialize in their business in 2011. But the market expected that earlier and is therefore too bullish. The same is true for the cement companies. What we like is when government intervention is a bit disguised and we are looking for the sectors that benefit in 2009 already, if in more subtle ways. For instance, banks. The banks are the biggest beneficiaries of the stimulus plans despite the political rhetoric that has focused on bonuses. However, soon the banks will be forced to return the favor and by then it will be time for us to invest elsewhere. Another example that profits from state intervention is aerospace. EADS is only selling planes today because the state, rather than the banks, is guaranteeing their exports.

  3. Second theme: “consumer downtrading”
  4. Life will be tough for the consumer, with taxes and unemployment increasing. We are looking for the companies that will benefit from the consumer downtrading, so we like low cost business models. We also like companies that suffered because consumers delayed a certain type of expenditure but that expenditure remains necessary. People have stopped buying for 6 months because they were afraid, but now they are buying again and catching up on their delayed purchases so demand is suddenly doubled. You have that type of situation in medical technology with Essilor (glasses) or Sonova (hearing aids).

  5. Third theme: “industry repair”
  6. This is when a sector has suffered from a crisis and overcapacity is being removed through consolidation. One example is UK real estate, where the market for UK housebuilders has brutally contracted by a third. It means survivors will create great oligopolies for themselves.”

Do you have other themes in store?

“We also look at more long-term themes. For instance, Energy: 5 years ago, the world thought it could solve the supply problem through alternative energy sources but it is now clear that this is not possible. Instead, the world is turning to reducing demand through energy-saving such as better insulation. Longer term, Saint-Gobain is therefore interesting, or builders like Bouygues that can deliver more energy-efficient buildings.

A second long-term theme is emerging markets, but in a new way. In the last 5 years, their growth has largely been driven by capex. The next five years will probably see the rise of the mass-market consumer, rather than luxury consumption for the “happy few”. Some western companies are well positioned to profit from that, the ones that have strong brands, even if their products get copied. Because it is that brand recognition that everybody admires. In a way, it is also free advertising. Up to now, this phenomenon affected brands like Louis Vuitton, in the future it could move to more mass-market brands like Adidas.

Other long-term trends that are also important to the economy as a whole are ageing, and deleveraging. But at this point, these are well known facts in the market, and it is difficult to have a contrarian approach on these aspects.”

How are your portfolios structured? How many stocks do you hold? What is your investment horizon?

“We are long-only investors and we are always fully invested. We only invest in European equities. Usually, we tend to have 20 to 25 stocks in our portfolio, but now, with all the opportunities we see, we are more likely to have about 40. At the moment, we are heavily invested in banks, media, logistics and consumer-related medical technology as well as residential construction.

We invest with a 2 to 3 year horizon. But what we never master is how quickly the market discovers the opportunity that we track. To circumvent that, we always have a very precise target price. If the market takes only three months to catch up, we move and look elsewhere. So our portfolio management is dynamic and we change our themes over time but I think that our current ones, i.e. government intervention, consumer downtrading and industry consolidation, are here to stay.”

How well has your strategy delivered since inception?

“Our strategy worked very well in 2006, less well in 2007, was a disaster in 2008 and is working again very well in 2009. In 2008, we focused on fundamental value and the stock market went much below what we could have anticipated. ”

How important is it for you to meet companies?

“Corporate access is key for us. Nowadays, most European companies are open to meeting investors so access is not a problem. We do not invest if we have not first met management. Meeting top or operational management allows us to understand the drivers behind the changes we have identified. In a second phase we will meet Investor Relations separately to allow us to quantify the size of change. We need to address specific questions on financials, like average cost of debt, tax rate, etc. to build our models and check our scenarios.”

How many companies do you meet per year? Do you travel a lot?

“I personally see one or two companies per day, on average, which is a lot. Our analysts have the same kind of schedule so KDA Capital meets up to 10 companies a day. We see companies in London but we also travel to continental Europe. I like to see companies in their offices because you gain a special insight seeing them in their “natural habitat”. But time constraints do not always allow for that. Apart from companies, we also meet consultants, industry experts, company stakeholders, etc. So we do not just “analyze” companies, we investigate them and their sectors.”

What are the most visible changes in the market since you started your career?

“When I started my career 15 years ago, added value was in getting information before everyone else. The internet did not exist and quarterly earning releases filled one page. The name of the game was getting in contact with companies before the “crowd”. Now we are faced with an enormous amount of information, so an investor needs to be able to sort through it quickly and efficiently. You need a simple, focused approach. You will not see all the opportunities but you will be able to act quickly on the ones that fit your strategy.”

There are many French professionals in the City of London, why?

“In a sector usually associated with Anglo-Saxon culture, a certain type of French mental agility gives a skill in the understanding of changing situations. That’s why, I think, you see so many Frenchmen working in hedge funds as well as Italians, who are the undisputed champions of intellectual flexibility!”

What is your current view of the markets?

“Today’s markets are very exciting because we live through extremely uncertain times with a lot of change happening. Our economic system in its current state cannot be sustained, with interest rates at 1% and public deficits at 10%. So in the short term everybody profits from it but within 12 months, more solid foundations have to be rebuilt. We are waiting to see what comes from our governments, our central banks and our companies. If they do not find long term solutions, the economy will fall further. It is party time on the markets but these good times are largely artificial.”

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