Bringing An Outside Perspective Through Transformational Activism with Mason Morfit

Welcome to a new edition of the Val Investing with Lions Podcast. My name is Tanos Santos, a David and Elsi Don't Professor of Finance at Columbia Business School, and the Faculty Director of the Helper and Center for Praham and Don't Investing. Unfortunately, Michael Magusin, my partner in crime and podcast, is traveling at the moment so he can not join us, but he will be here for the next interview. And he's going to be missing what I think is going to be a very special episode. As our listeners know, at the end of the last season, we had several guests who were leading the activists charge in Europe. We had interviews with Jan Humel of Praham, with Ansofid and Loves Yam, and with Klaus Rory and Florian Schoepauer of Active Ownership. All with wonderful insights on how to create value through a robust engagement with management to improve operational performance. I have said several times in the podcast that in a world of plentiful capital and compressed yields, activism being the agent of one's returns is a way forward. Few firms exemplify my mind, the value creation associated with shareholder engagement and activism better than value act. And I'm delighted to welcome to the podcast Mason Morphit, Chief Executive Officer and Chief Investment Officer of Value Act Capital. Mason, welcome to the podcast and thank you for coming. It's great to be here. Thanks for having me. Mason Morphit is a partner that Chief Executive Officer and Chief Investment Officer of Value Act Capital, a governance oriented investment fund with over 14 billion dollars in assets and the management. Value Act actually has a highly concentrated portfolio of 10-15 companies and one of its partners have served on the boards of directors of 44 public companies over their life of this great activist fund. In particular, Mason has served as a director of Microsoft Corporation, Balean, CEO Bard, Immokor Advanced Medical Optics, Alexa and many other companies. And in addition, Mason has lecture on issues of corporate governance and executive compensation in many places in Stanford Law School, at the Graduate School of Business at Stanford and we're delighted to welcome you to the Value Investing with Lianz podcast on that pedagogical capacity as well. He serves on the board of directors of the Deep in Point community and he has a BA from Princeton University. So Mason, thank you again for joining us and welcome again. Thank you. So Mason, will we start with this podcast with your early years, your education, your background? What brought you to finances is something that runs in the family. So what do you tell us a little bit about that? I know I'll leave it about your background and I'm sure the audience will find it fascinating to know of that very different background of yours. I was born in the UK. My mother's British, my dad's American and they were at that stage, my dad was a grad student in political philosophy and then they moved to India to do nonprofit work and eventually to Indonesia where my dad worked for the State Department doing international development. So they couldn't have less orientation or interest in finance. But my upbringing was sort of all over the place in different countries. I went to a British school in Indonesia and eventually moved to Washington DC when I was in sixth grade. That was an interesting kind of global experience but it was also one of having to assimilate to a new culture and this is pre-internet. There was no television broadcast in Jakarta when I was living there. It was a really sort of arriving as an immigrant at a pretty tender age. One of the things I talk about in Value Act is that we are very often, the metaphor I use is inviting ourselves to the dinner party. We're showing up at a company and say you didn't ask us to be here but we're here which is quite a rude thing to do but I think by the end of this dinner, by the time we get to dessert you're going to be glad we rang your doorbell and showed up. But I think some of this experience of sort of being an outsider and having to assimilate with lots of different cultures and scenes is part of my formative experience. I then went on to college and I was an econ major there but what interested me about economics at that age was not finance. It was the mathematical modeling of human behavior which I thought was interesting, the intersection of mathematics and psychology. Not literally and this was before behavioral science was a thing. The intersection of the rational and the irrational reason and emotion, sort of objective fact and subjective interpretation. My junior year I wrote a paper on Mahatma Gandhi's economic theory which sort of contravenes the idea of homo-economists always wanting more, greater consumption. Fascinating actually. What's your imprinted in Mason? I graduated in '97. '97, that's amazing. In '96 I went to the department that offered the idea of writing a thesis on I didn't have the term for it but the concept of sort of irrational behavior and altruistic behavior and what that meant for economic models and I was told that no professor in the department would support that thesis so I didn't write it. But the idea rattled and ended up writing about income inequality instead. The coursework I did was sort of balance between psychology, philosophy and economics. I found those topics quite interesting and I think the echo of that later at Value Act presents itself in sort of how we interact with companies and trying to bring objective fact to help break through personal biases and group psychology, things that maybe paradigms that maybe holding back companies and we can talk a little bit more about that later in the session. I then thought I wanted to go to law school and then forgive me for saying it but I worked at a law firm and decided that was not for me. And then I ended up at Credit Suisse first Boston. Interestingly they had an investment research pioneer there named Michael Moboson at the time. He told me he was very sorry he couldn't be here which is quite a pity because I think it would be wonderful to have you talk to each other on that face. And what he was doing was fascinating at that time because it was taking lessons from biology and other fields and bringing them to find out what I thought was very intellectually stimulating. And unfortunately I was not in that department. The healthcare department, healthcare services. At a time when the bull market was absolutely exploding in technology land and Credit Suisse first Boston at that time was the leading issue of tech IPOs in the bubble of 98 to 2000. I was in healthcare services which was in the opposite scenario because both went and had just balanced the budget on the back a little bit of Medicare cuts. So I watched the industry really both mature adjust to its consolidation but also the incredible headwinds and incredible accounting complexity. I was in probably the least sexy or cool part of the bank but it was frankly more I think interesting to analyze and watch an industry in sort of a tectonic shift and in some cases company collapse than it was I think in the tech department just issuing things that were fairly unambulant. I mean it's interesting. I didn't know that you were there doing those years. How do you solve is your first if we abstract from the period you were in the long term is your first job in finance and you jump right in in one of the biggest bubbles in history or an interesting period in valuation. Let's put it this way. We want to not use the word bubble. So what lessons do you get from that? How did it look to you from that department as a young man learning your chops in the finance business? How did it look to you? What lessons do you get from that? It's an interesting segue to the value act journey because the whole time I felt unsettled and I didn't get it. Because of what I was seeing rewarded didn't make much sense to me with respect everybody was working there. There was so much going on that a lot of the analysis was somewhat superficial or focused on incremental data points. This hot products coming up in trivia. So I learned a lot about how capital markets worked. I absorbed Movisons work. I interacted with all aspects of the ecosystem. At that time alternative investments were fairly near. There weren't that many hedge funds out there. Then a friend of mine had worked with a guy named Jeff Obin at a firm called Blum Capital and said go meet with Jeff. He's starting a firm and Jeff made me work for free for a couple months and we would go visit companies and I watched for the first time something that actually lit me up. Made me say I get it and this is what I want to do. And what I saw was an investor engaging with the CEO on a real human level about long-term issues that they were facing, long-term strategy issues and as well the organizational psychological pressures that had been put on them to make decisions in the past that had gotten them in trouble today. They had overstepped or overreach on a diversification strategy or they had made that choices with people. Something that had gotten them into a period of underperformance and how are they going to get themselves out of that and how to sort of step forward. And it was so different than the conversations I saw elsewhere on Wall Street which were about who knew more about the quarter or the incremental trends in some revenue line or predicting some margin to the basis point. It just seems so much more substantial and meaningful. When I was thinking about this interview, this is a point that stood out to me that you're career in that particular moment. This kind of overlay between the very short term factors that were driving market valuations in the late 90s with something like activism, engaging value creation in the very long-run operational performance, governance issues and that kind of groundwork of slowly building something for the long run rather than for the immediate result in the quarter that you were able to make that transition. I thought it was very interesting about your biography as an investor that you were able to see that so clearly then. Yeah, I think I was sort of going with my gut as much as anything and just something that felt right. And remember, at the time we were targeting, we were doing small-cap value investing in the launch in 2000. At the time when large-cap growth was all the rage and it was probably the least interactive again, place to be at that point in time. It had a few other issues with it. One being the idea that you could even be in the dialogue with its CEO or board of directors at that time, just wasn't how the world worked. We as a sort of business community celebrated the Imperial CEO, Jack Welch, Bill Gates, Sandy Wilde. These are people who are larger than life. They didn't answer to anybody and we launched a firm with a mission to do that to have a long-term perspective engaged on these issues. Upstreamed from that to even be in the conversation was presumptuous and not the way the world worked. So we're targeting a backwater of the markets with a strategy that was ludicrous on its face, but we got lucky in some respects corporate scandals hit in 2001, 2002. So NRW, Delphia, Tyco revealed that these corporate chiefs were not as infallible as we might have thought. And when you have accounting fraud and self-dealing in these scandals, they're sort of a repetitive cycle of history where crisis and scandal regulation and forget sort of sea changes and how governance works and how Cheryl Lewis interacted with companies. And so that was a massive shift. You had Sarvaine's Oxley law passed by Congress, the Stock Exchange listing requirements shifted, but more importantly, the idea that it's Cheryl's had a role to play became more acceptable. And that was a big pivot point. 'Cause prior to that happening, we were investing the way we had invested, but we were finding it difficult to get on boards, we do it by negotiating a deal with the VC firm and buying their stake or a founder or something like that. And after that, we got more welcomed. - Sarvaine Oxley is 2002, 2003, if I remember correctly, right? And that's when you get more into, I'm gonna be doing this. We're gonna be doing this ourselves rather than through a VC like vehicle, is that what you mean? - What I mean is we were investing in small-cap public companies, but we would say there's a founder that needs to liquidate or they need to pipe investments. That was how we would get board seats or get sort of formally onto boards of directors prior to 2002, 2003. After that culture of corporate governance change, and when we approach the companies that, hey, we are your number one shareholder and we own seven percent of your company and we would like to talk about a board seat. It shifted to something that was much more receptive. I think because of the scandals and the regulation changes, the whole world from sort of a shareholders which we've seen but not heard into something much more integrated. - And can I ask you this, were you guys aware of that kind of environmental change that kind of those scandals favored? The particular form of shareholder engagement that you guys wanted to implement, that is the right moment to do this given this mood change associated with the scandals and then socks in 2002? - No, because we launched in 2000, so two years prior, we had no idea that that was gonna happen. We just were leading with what felt right for us as an investment strategy. Over time though, what those doors being open allowed for, you talked about the number of boards that we've been on, I've honestly lost count and some of the companies we've had multiple partners serving on the boards, but it's north of 50 board seats now, they get into a cap of double counting. But that is a more lifetime experience than any human beings ever had. And over time, we accumulated two competitive advantages that we continued to build on every day. One was just a network of people that we knew, people that we had worked with, people that trusted us. And that helps you because that allows you to access any company in the world by picking up the phone and calling a mutual friend and saying, well, you make an introduction. Increasingly, we're also using it as a bench of talent to help us address certain problems in our companies. But that's something that you can't build overnight. It takes us 20 years to build this network and reputation. And that's both in the executive community and the institutional investor community. And the second is this thing that I, starting about 10 years ago, said we need to formally document all the lessons that we're learning in all these boards because we are going through CEO transitions, strategy shifts, compensation plans, M&A, crisis management, all these things over and over and over again. And unlike the typical independent director that maybe only has one, two or three of these experiences in their lifetime, we're doing this at such a velocity that we're seeing so much we should document and learn. What is it when Microsoft did its CEO succession plan and hired Sachin Adele, how do they do it? What did they learn? What did Motorola do and it overhauled its budgeting process? These, but what have we learned about executive compensation? These things, but let's document these and we write them down and we call them our value act toolkit. And let's teach them to each other as a partnership so that everybody walks into a board, empowered by the life experiences of all of their partners and you walk in not just with your own one or two board experiences, but this 50 plus experience set. - This is a wonderful message because I keep telling this to the students in class that it's absolutely of the essence, not to throw the knowledge that you create in every situation away. First you have to record it. What happened? What was my thesis when I went in? What happened that didn't go well? What happened that went well? Did it go well because I just got lucky or did it go well because somehow my thesis played out the way I foresaw. And to start building that repository of information that allows you to construct models that then you can take to a different situation. Is that how you guys see it as well? - Yeah, it's for kid-rich spirits because I'm a huge believer in just note taking and journal writing and explicitness. - I'm delighted to hear that. - The thesis acts anti and then acts part-day. So if you have it like written down in the locked from when you were going in because what happens to all of us and it's particularly dangerous for investors is revisionist history and allowing the emotional mind to take over and rewrite what you were doing incrementally, slowly over time rather. It is okay to change your mind. It's okay for facts to change. It's okay to be wrong. One of the things I tell our team is it is okay to be wrong, but it's not okay to lie. - Exactly. It's the self-attribution bias. It's one of the most pernicious bias out there that you think the good things happen because you're super smart and the bad things is because the God's word against me. I mean, it's one of the most dangerous things when you have to peel institutions and no taking diaries is a good way of doing it in my opinion. - Absolutely. And to have the culture at your firm that allows for sharing of that, but the good in the bad and the alignment of personalities but also a mission so that you want to help your fellow coworker with everything you've got and receive it back in space. Now, one of the points I do want to make is this accelerated life experience being annotated and shared met this opportunity set because I think the job that we have assigned corporate boards to do or public company boards to do is just a very, very, very difficult job. We take a group of 10 people and assign them with a meeting maybe four or five times a year to oversee a company which none of them have any life experience in generally. If you look at the board, because of conflicts of interest and stuff, you end up taking people from other industries. We load them up with regulatory compliance demands ever increasing. And then we give them only information or mostly information that flows up through the bureaucracy of the company that they're overseeing. And then we structure it in these committees that are not integrated. They're separate, they have separate charter, separate advisors, as comp committee advised by a comp advisor, audit committee advised by auditor, et cetera. And say, okay, go make the most important decisions that this company has to make. And we use to sit there and marvel at this, our belief and everything I've seen in my career is that every public company director I've ever worked with has been really well-intentioned, really smart, really conscientious in hardworking. But you've set them up with that assignment. And into that setup, we created an investment strategy that would help address these things. If you think about the time, for one instance, four or five times a year, these boards of meeting, this is a full-time job for us. And the partners that are working on our investments have, at some cases, billions of dollars at stake, and they are going to every trade show, talking to customers, doing surveys, meeting with the CEOs of competitive companies, taking the financial reports and doing extensive analysis on it. So we just have more time. All of that work builds expertise. And I talked about our bench of executives that also wins extra expertise. But we'll also engage management consultants to do lots of work to get very smart on it. We don't have the bureaucratic biases that the reporting hierarchy creates, because we're standing outside. >> What are those biases, Mason, sorry, do interrupt you? >> So for instance, when I was on the Microsoft board, Sachin Adela would call me up and say something like, my team wants to maybe acquire this company. What do you guys think? And would you do some analysis? And the reason our best CEOs would make those kinds of calls is because they're aware of the fact that the team that wants to buy, let's say, LinkedIn in this case, has a bureaucratic imperative to increase their line of responsibility or-- >> For creating a phone. >> For an outcome rather than dispassionally evaluating an outcome. And that is true for M&A. It's really true for anything, for personnel decisions. And we call this bringing peripheral vision to the board room and our best CEOs and best boards love it. They'll say, will you do extra analysis for what do you think? Will you present to us on this issue? That is not intended to replace the information flow that goes through the board, but to supplement it with some extra outside and independent point of view. And it is not in conflict with the company at all, because as I said, our best CEOs like having a sort of devil's advocate or a sanity check or a different second opinion or something that comes from somewhere outside their own organization. And the last thing that I think we do is we work very hard on integrating the work of all these committees, because I think they all ought to be in harmony. The strategy of the corporation should determine the leadership choice or the CEO choice. The board books and the KPIs and the financial reports ought to be reinforcing of that strategy and of that leadership team. the compensation should be tied to the KPIs, which were tied to the strategy, which were tied to the people. The investor relations story ought to be tied to the strategy of the team, et cetera. And too often, the organizational structure of a corporate board doesn't really allow for that type of integration. And in fact, compensation is generally informed by benchmarking against other companies in the industry and where you're in the 75th percentile, the 50th percentile. I'm like, that's interesting data and should be incorporated. But most importantly is, what outcomes are we trying to drive this company to, what time frame? And that's tough for a compensation committee to do in a vacuum, or unless it is fully integrated into all the other flows. And the same is true for all the other committees and functions of a board. And so I think we bring this time, expertise, lack of bureaucratic bias for a federal vision, and then integration for us. And so that, again, we didn't immediately hit the ground running knowing all this or having this experience. But it was what emerged after serving on all these boards and watched them struggle and succeed and fail and make mistakes and learn and piecing together. What was the issue that we could help? But I love this idea, Mason, that somehow, let me see if I can say it back to you. When thinking about a particular company, have to start by thinking about what is that they're trying to accomplish? What is this strategic outlook that they want to pursue? And then I have to align all these institutions from compensation to everything else around that strategy to give it a maximum chance of success. And what happens in many of these organizations is that because of organizational drift because of having internal symptoms, because of people are trying to maximize the footprint, bureaucracies, tend to do that all the time, what happens is that slowly this institutional arrangement that is internal to the organization is not fit to the particular strategic outlook that the company wants to pursue. And you see your role as bringing all these things back in line again to give the company the greatest chance of succeeding or whatever it's attempting to do. Is to understand that correctly, to bring all these institutions together and align in the right way. - That's very well said, there is an extra layer bear with me, I know this is-- - No, no, I'm loving this. - An academic. - No, no, that's exactly what I was supposed to be. - So yeah, I think I'll tolerate this. But there is something else that happens, which is out of that corporate history, the people that are there, the institutions, et cetera, can often emerge psychological paradigms. And some psychological paradigms are quite helpful for certain stages of a company's life, but then they become hindrances. A good example would be Microsoft's view that Windows should be prioritized over everything. And for a long time, driving the supremacy of the Windows operating system was a fantastic strategy and worked wonderfully for decades. But in 2013, when we invested in it, that paradigm was holding them back because that led them to do things like by Nokia, because their premise was that they needed to win the phone war and beat the Android phone and the iPhone with the Windows phone. It was our perspective that that battle was already lost. And so what you actually did to do is do the opposite, which was embrace other operating systems, put your services and software across other OSs and live in a multi-OS world. Other companies have paradigms like Go Bigger Go Home, Growth at All Costs, and that may be great in a startup or even for a decade or two, but eventually that leads you to make bad decisions about strategic sprawl or diversification. There are other companies that we've seen that have viewed the ultimate measure of success as earnings per share growth, and that's their paradigm. And so everything strategically and institutionally and compensation is designed around driving 15% earnings growth, blah, blah, blah, blah. When sometimes actually the industry can be at such an inflection point that the right thing to do is to take earnings way down because you need to either invest through the income statement in more R&D to retool the product. Or maybe it's shifting your entire business model. In the case of Adobe, they had to shift from a software license to a subscription model, which took any time by two thirds. So if you had had a paradigm that earnings growth was the ultimate measure of managed your real success, you would have made the wrong decisions as opposed to the right decision. And so all of these things-- and this is sort of where I think that's almost like an emergent organizational psychology or a paradigm that needs to be broken or released and reset. And again, all of these things yield to analysis, truth, and effects. And this is kind of like back to what I was talking about. The irrational version of the rational effect-based decision that is the first-ly emotional decision that historical legacy versus embracing change, I think, is a big part of where we see opportunity to create significant equity value. Because these companies very often that we're addressing underperforming and are perceived to have been left behind by history, doing the wrong thing, can't get themselves straight. And a lot of it is shifting these dynamics. But I can see the value of this, because I can't imagine if you're inside Microsoft and you're trying to push-- when the mobile revolution was a food when it was starting in 2006 to 2010, say. And I remember the fights between very correctly Microsoft and Intel to develop kind of a product that could rival the note pads and all those things that were coming out of the time and the effort to get windows in every single platform. And in a way, I can understand if your Microsoft-- well, this is what has made this company to some extent what it is and why should it work? And who is going to be the first person inside the room who's going to say, guys, we really have to think differently about this one. And I can see the value of the outside that coming in that peripheral vision that you were mentioning just a moment ago and said, maybe this is not what we should be doing. There's another way of playing this one out. And we can emerge the winners of this situation if we're able to actually play not through this product that we've been so successful, but place in other software in different platforms and just basically write this phenomenal way that we're too late to really contest at this stage, which is one way you could think about it. I was very impressed. I was thinking a lot about not so much about Microsoft, about how Intel had missed and had led arm holdings, essentially, take over the side of the market. These are great organizations, Mason. These are great, great companies. And somehow they were caught missing a step in this massive revolution. But it takes a lot of human courage to some extent to say, guys, we've lost this one. Let's move on and let's do this other thing because we still have a role to play. Well, it's interesting because the definition of tragedy and literature is the hero's greatest strength becomes his greatest weakness and undue. Absolutely. And that is what very often happens because it works so well, so well, so well, so well, until it doesn't. You mentioned two companies because this situation in a way strikes me as different than the Adobe situation, which was a particular technology becomes available, a particular new way of delivering your product becomes available through the cloud. And now it's a question of operational implementation of this strategy. So Adobe, it asked these very successfully. One was in 2013, 2014 when they did it. 2011. 2011 started. And I remember those things flowing through the income statement. The pressing operating margins quite dramatically if I remember correctly for a couple of years. And I remember thinking, this is going to work out. I mean, it's a great company with a fantastic product. Give it a time. I'm sure they will make some mistakes in the process. They were an early mover in this transition. But we just played out beautifully, I would say. That's a different situation. That's a transformation and helping a company do that transformation by providing permanent capital by, I guess, providing support. Providing support from the board that you are doing the right thing. So these two different things. One is a pure disruption in innovation. Hey, what are we doing this situation? The other one is we need to transform the business to adopt to the new times. I think there's a lot more income in there. And one thing I should say is that in all of these cases, all the credit goes to CEOs and the leadership team for driving. That's an art job to help support with analysis and as directors. Imagine that Adobe case, they think about a company that has been built to sell shrink-wrap software through retail distribution. The engineering challenges of that, the production challenges of that, the relationships they have with their channel, the pricing expectations of their customers. All of that had to be ripped up. They had to upset, walk away from retail relationships. They had to completely change the relationship with the customer, change the engineering of the product. So it is very fundamental these transformations. One of the things that we talk about as our style. We don't really love to like use the word activism. But if you had to, there's transactional activism, which we view as very more short term, things like sell your company, break up your company, recap your company, do an operating company, an op-code, financial engineering, do that kind of stuff. And then there's transformational activism, which takes longer and requires a deeper commitment and a deeper trusting relationship with the company because you're going, and it's multi-dimensional. It gets into the right people, the right strategy, the right KPIs, the right compensation, the right investor messaging, the right et cetera. So we have tooled our firm to do transformational activism, not transactionalism, but it is quite rewarding and meaningful because you get to work with great leaders. And intersect with companies at very interesting points in their corporate history and their industry history. Those are two examples we just talked about. About client server architected technology companies shifting to cloud and mobile technologies. Fascinating time in the technology industry. history. We were also there when Fox had to deal with the shift from cable television to streaming television and what to do about their stake in Hulu and what to do about eventually as you know, we're in it with them merging their cable networks with Disney to create Disney Plus, which is one of the great success stories of the streaming era, but we would have got to participate in that conversation at the banks that we're dealing with Morgan Stanley and city group What is the bank of the future look like and at the time that we invested eight to ten years after the credit crisis and regulations had finally settled what was their future at KKR where we invested in 2017 this was a era where the private equity industry was structured mainly as publicly-traded partnerships and still founder run and in general heavily-weighted the US private equity product like what was the future of the alternative asset industry and how should the corporations be structured and how should the leadership We get to be it's a little bit like forest gump the movie was doing what I was thinking interesting times because that is where you find companies that are great and have transformation opportunities but are not appreciated because of where their recent history and where they're perceived to be misaligned with the sort of technological, social, economic trends of their times they seem to be out of staff and we help work with them on bringing them back in-step and I took over as chief investment officer of value act in 2017 and then as CEO at the beginning of 2020 and I synthesized what we have been doing and tried to articulate it in clearer language but our mission is to help transform companies to make them 21st century global champions that means we invest in incumbent businesses So not generally the startups because of our value investors we invest in companies that have cash flow and products and distributions and customers and try to get them to embrace the technological and economic realities of their time and become real champions and that's a strategy that when well executed means you're entering a value stock so when we've invested in Microsoft it was eight times earnings Today it's 35 times earnings and its earnings have exploded you get the double benefit of increasing earnings power of the company and fundamentals of the company with valuation and perception at the same time and so we draw a little simple two-by-two matrix and we say with the companies we invest in are sort of underappreciated so their perception and valuations allow and their fundamentals are not great and we move them horizontally to excellence in fundamentals and then vertically in terms of sort of appreciation and valuation multiples and that's how we create our alpha and it sounds like so much fun to tell you the truth these transformational investments so to speak you have a front row seeping these transformations that we have lived through over the last few years which are absolutely massive in a way so that I mean, Crowley jealous, you know, I'm sure the stories and the insights are just simply phenomenal now can I ask you something sort of a little bit conceptual but we struggle a little bit with these things sometimes in class which is the traditional take on value investors is that you really want to pull margins of safety around the things you don't know so that you can have some confidence that should the things turn south or in a way that is not positive you're protected and your capital is not in pair now when you go into a particular situation you think it well Microsoft is trained at eight times earnings but I think if they do one two three this company can be at 30 times earnings you must want a numerous amount of work in order to have confidence on that you see a path maybe it's very clear to the wonderful people inside value i and then there's a reality of I'm going to go in and let's see whether they can implement this whether they're going to be on board with this plan what kind of surprises operational in terms of implementation of that plan what kind of organizational capabilities you guys need to assume so that that plan that you guys have put together is indeed one the company can deliver on are they surprises there that the plan is wonderful I just don't have the team to do it internally or there's been a surprise flamplacian surprise this is not going to work because one two three what kind of assurance do you have when you go into a particular situation that that plan can be implemented I mean we can all make plans what the company should do and then there's a reality of implementation is your challenges tool so not only the challenge of valuation that anybody investor has it was a challenge of implementation so can you talk about that let the challenge when I went back in my study I went and took over the formula the leadership of the portfolio I just looked back on like where we've been very successful and where we've been less successful because like every firmly hits and it says and I said the ingredients of success for us were always two things a unique insight and meaningful engagement and the unique insight meant we saw something that others didn't see and a unique insight is not an opinion like I believe interest rates are going up or I believe the unique insight is I've looked at the unit economics of your contracts as something very fascinating is happening this is changing or they're incredibly resilient because of xy and z or we've done a customer survey of your distributors and they're telling us this something that is actually grounded in deep deep research and the best insights when shared with a good leader big-gett meaningful relationships because the receiver of this at the company says oh my gosh that's so interesting I'd like to come back and do another meeting with us and so many investors I think are in a transactional relationship with companies when they come visit their offices where they go to their take a meeting and they're trying to get information out of the company we try to share as much as we can as we get we call that a learn teach relationship we want to create a learn teach relationship when you have an insight that is interesting it definition like creates meaningful engagement because a good example to be more instantly at the time that we invested it was perceived as a sub-scale risky investment bank that was failing and fixed income trading and yada yada and I had all these other things wealth management equity trading and investment banking advisory James Mormons inclinations were already heading towards wealth management as the center of gravity for the company but we did a survey of wealth managers RIAs people at Merrill Lange people we I think we had hundreds if not thousands of people who were participating in the survey and had some takeaways about what the benefits of technology and scale were that more insanely could leverage to really drive further growth and consolidation in this market and we shared it with James we just emailed it to the CEO and 20 minutes later he responded he's like this is really interesting slide six makes me laugh because because that's something that's a real honest man for you we had a sort of irreverent quote from one of the people that worked for him and he said this is good why don't you come in in a couple weeks and meet with my team that runs this division I really like to see them respond to this work you've done and that's an illustration of something that happens continuously for us where our unique insights are banged against an organization and if we're on to something we get sort of drawn into a conversation that gets a meaningful relationship and in that sense in that particular one no one ever joined the board from value act we ended up having a fantastic run we invest in the stock at 27 today it's 100 and state as outsiders never the last had the insight and their relationship at half or more of our investments that meaningful relationship evolves into a board seat and there'd maybe an interim step of an NDA to work on a specific project but ultimately ends up with a board seat and so there's a natural selection to this which is if we're like way off a big problem in our investment these could be we just got it wrong and we're sitting here daydreaming about a fantasy that's never going to be reality exactly and the iterative process of being able to sort of interact and engage and create these learned teach relationships helps us avoid those mistakes while simultaneously diagnosing the organization capability and it's not just capability it's will and it's paradigm like I talked about and are they sort of psychologically be holding to something that doesn't make sense anymore and what I firmly believe in is that the truth always wins and so by having an insight having an engagement and the iterating and iterating we sort of get to truth we get to truth collaboratively with the company that we're working with and then they inevitably embrace it that doesn't mean things always go right you can have that luck a big investment we made that we didn't make money on lost money on his role's Royce which is a jet engine company we knew that there was a huge operating performance gap versus GE and we knew why that was happening and how it could be closed but then in the middle of our investment they had to recall one of their engines and then COVID had the aerospace industry and so those kind of things do happen but the overwhelmingly majority of the time the vision that we have for transformation is inherently fact checked by our process of working with the companies and we've been off base before and then we say okay this investment's not for us and we may have built a hundred million dollar position and we just reverse it and go back to zero and go look at something else but if we're right about something we know because of the signal we get back from the company we're working on and if we're right then we start engaging collectively and then we get to the truth and the truth always went. It can actually very briefly about this so I love this idea of organizational diagnosis as you bill your case you try to understand the capabilities of the organization that's value act consider management change you guys inject always a point of target selection that we're going to invest on those companies we think already have the organizational capabilities to implement this plan. So remember that we're investing in these incumbents that are pretty well established companies so they're not immature organizations that are lacking in experience or capabilities the problem for us is generally choices to resource allocation don't make windows phones drive Azure in office 365 and empowerment If you go out of this conception, I think, in the investment world that corporations are these monolithic entities that speak for one sort of direction or philosophy or strategy to close on the CEOs, they're actually communities. And they're communities that have tribes inside of them that have been sort of advancing different sort of worldviews. When you bang the truth against this community of tribal warfare that's going on in the surface, you empower the side of truth and it tends to rise up. So you tip the balance a little bit inside the organization. That's how you see your role as well. To deep the balance in favor of the right group, the right tribe, so to speak. And do it in a way that is not personal, but just based on facts. Here's the facts and let's all look at them together and get to the right answer. So when you say capability deficiency, I think about like they don't know how to sell internationally. These companies don't have those problems. What they have is a problem of prioritization and armament and choices. And those are inhibited by history and paradigms and all these things. And so that's how I see it. You guys have begun to extend the value at playbook abroad, particularly in Japan. And most curious about how is that working out? It's a very different governance environment. Japan has had obviously an incredible corporate sector while at the same time being settled with some concerns about corporate governance and how receptive Japanese management has been from feedback from our site. Let's put it mildly. How is the value at playbook being extended elsewhere? It's interesting how history echoes because I told the value extort about us launching in 2000 and the corporate scandals of 2002 and then the regulatory, yeah, yeah, I would change attitudes. And at the time that we intersect at the boards being sort of just understaffed, under experience to meet the challenges of this new job that they've been given and what we had to do with the toolkit to bring it to life. If we think about the Japanese corporate governance landscape, first of all, as you said, a country that has a tremendous history of engineering, innovation, and great companies. There was a very analogous outbreak of corporate scandals in the '20 teens in Japan, Olympus at an accounting scandal, Toshiba at an accounting scandal, Kobe seal at a faulty products certification issue, Takata Airbag recall, all this stuff was going on in the '20 teens, which resulted in Japanese government and corporate community re-evaluating corporate governance standards and publishing a stewardship code in the middle of the last decade and stock exchange listing requirements changing. And then from the top down in the Japanese government, it desired for both more foreign direct investment into the country, but also a desire to drive for global excellence at their firms. That seemed quite similar to what we saw 20 years ago in the United States. And similarly, boards were changing. The statistic that we've looked at, it seems like kind of a low bar by our American standards, is for Japanese companies with public companies that have one third or more of their directors being independent and that work, not employees. That number didn't cross 50% until last year. And that's a pretty low bar. So the majority of Japanese directors, employees at the company work for, which by the way, is not that different, similar than what American companies look like in the 1950s. But anyway, you have a pie chart of independent versus inside directors is shifting in the favor of independence. The business community has a recognition that the board has a very important job to do in terms of oversight and you have support from the government for all of that. There is, and I can bring this to life with, Olympus was our first investment in Japan. And we decided to approach Japan with the same assets and style that we had in the United States, which is unique insight, meaningful engagement using our network and our toolkit to add value to these companies with a special emphasis on elevating corporate performance to global best in class. And so Olympus at the time we invested was a conglomerate that made camera scientific instruments, all the profits when you broke down the analysis for coming from the medical device business. And the medical device business was also underperforming US medical device businesses in terms of profit margin by a factor of two or three, was around a 10% margin in their companies in the US that had 25 to 30% margin. Our insight there was that they should simplify the company no longer be a conglomerate. This is again a paradigm of diversification and history and corporate legacy because when I say the word Olympus, most people think camera. Exactly. The famous photographic camera. Absolutely. They devastated a letting investment. After we invested in the company, they eventually divested something that had been the identity of the corporation because making, I mean, I don't need to tell you this, making digital cameras in 2018 is not a great corporate strategy. Am I mistaken that we're already an important, I mean, most of the revenues were coming from medical equipment rather than the cameras I assume by that. Most of the profits, yes. Most of the profits, yeah. And yeah, the profits are still sort of under. So I have to give tremendous credit to my partner, Rob Hale, who has led our efforts at Olympus and Japan in general, to build a relationship on the basis of sort of this investment thesis about focusing on where you're great and not fighting battles you can't win and then targeting best in class profit margins, which sounds like a simple row in a spreadsheet, but it's not. It revolves an entire organizational redesign about how are your global affiliates in China and the US going to be organizationally structured to relate back to the US. How is our indeed going to be structured centralized versus decentralized? What is the innovation cycle going to look like and what is your track record of getting things approved by the FDA? How does that compare to very transformational in that particular company? We brought the Rob got a board seat, which is a historic event for a American investment firm like ours to get a board seat at an EK225 company. And we got a second board seat for a guy named Jim Beasley, who'd been an executive in CR Bard, a medical device company in the US that I'd served on the board of way back in 2009, 2010, who I viewed as the best executive in the industry to help them raise their performance to go up here by taking the best person from the best performing peer. And so that's the power of the value back network, insight, meaningful engagement, etc. There's some other color that is very fascinating to me. Like most Japanese companies, Olympus had a board structure called the Kansai-Aki board and there's a lot of nuance to it, but these boards are generally staffed with insiders and outside auditors. They meet very frequently and they have a lot of approval responsibilities about items that in general by our standards in America would be too small to delegate to a board for approval, just audit approval and frequent small decisions rather than elevating to 30,000 feet and thinking about strategy management, composition. And so around the time that Rob and Jim during the board, the company changed its board structure from a Kansai-Aki structure to a committee structure board, which is something more similar to what we see in the United States. And so you see a company that is at a governance level shifting how it functions, globalizing, internationalizing and making more independent its board, pursuing a strategic vision, a financial target, an organizational structure in human capital. They also changed CEOs and talk to you. Chiefs on the CEO, there has been a fantastic partner to us and done a great job. So all of that is in many ways exactly the same work that we've done at our most successful American companies and partnerships. But with the Japanese flavor to it and talk about learn, teach relationships, the work that we've done with talk to you. Chiefs on there has been a fantastic one for us as our first journey into that country. We have followed up that investment with a company in JSR that makes supplies and services for the semiconductor manufacturing and life sciences markets as well as Nintendo and then the Seven and I. So we've now made four big investments in Japan. Rob has joined the board of two and the track record so far has been great and it's been really rewarding in terms of what we're learning there. At the time that we started this initiative, we were told that Japan was like a terrible place for our investment strategy because so many people had attempted it and failed. Now when we looked at it, the strategies that have been attempted were confrontational and were either litigation oriented or shareholder elections sort of oriented rather than transfer and were transactional in terms of investment. We were leading with something different which is transformation and global excellence. And furthermore, we leaned heavily on our global network by this point of executives that had worked with us. So one of the things the Olympus Management team did was they got on a plane and went and visited the folks in Chicago to talk to the Motorola team and see how to get to know the people that had actually worked with us and here firsthand of what it was like to have us as an investor. And we made it that that mission, which is different than a transactional mission, combined of the reputation and work that we had done could be a key that unlocked this tremendous investment opportunity. And frankly, at a really interesting point in history, so far so good. And I think we will continue to do more. I think it's a wonderful idea that in a way what you are signaling is this commitment to the business operation of the firm and the future of those business operations through this transformational approach rather than I want you to distribute at the event or I want you to sell that and give me a big bit of payout, which is transactional nature. Maybe the right thing to do, I'm not disputing that, but it's very short term oriented and it's not focused on exactly this. You know, the essence of the business operation of the firm in the context of the norm of changes that we're living through the world today. So let's talk a little bit about that. Let's talk a little bit about the future in this last segment of our conversation. So first, can we take a step back? Do you agree with that premise that I put at the beginning that in a way we lead to some extending the golden age of activism, We need to get all these companies to the efficiency frontier, even that yields a very compressed, so you have to be the agent of your own returns. Do you agree with that premise? We're living through a great age of activism that we're going to extend these best practices that have been the new in the United States to the rest of the world to Japan, South Korea, Europe, and so on and so forth. Is that where we're heading? I might parse that a little bit. I think you're correct that it is the only investment strategy that I believe in. It's never been more relevant than it is today because of how highly priced equity markets are because of the amount of transformation that's going on in the economy, technology, the pandemic, and then fiscal policy. So I believe in that. In terms of the golden age of activism, if we look back at the time that I've been in this business, there have been two sort of activism bubbles. One was before the credit crisis, when if you were a transactional activist, it was great because there was some private equity firm to leverage up and buy companies, like financial engineering, all kinds of crazy stuff. And then in the 20 teens, there was an era of hyper operational excellence and aggressive execution. I would say most personified by companies like 3G that also catalyzed a lot of corporate action, a lot of sort of returns to activism. There was a interest just like it always happens in life. The side effect of that was that many, many companies did it to themselves. They got much more disciplined, proactive. We started to see it happen. We would call a company to set up a meeting with really no agenda yet because we were embarking on our learning journey. And all of a sudden they'd like buy back a bunch of stock and maybe announce it's been off for something. When stealing feel ready, just that phone call, what's the reason? For no reason, sort of like we actually had nothing. You're a threatening guy, Mason, I can see you. So I think the opportunity set, the most robust time for an investment strategy is when the opportunity set is massive. And I think for transactional activism, it was there and then it started to shrink. And that's why I think you see a lot of firms that were pure activist investors are no longer around or a diminished or have shifted their strategy because of the fact that a lot of companies have done it to themselves. So the more turbocharged operational excellence strategies like 3G have sort of not been as successful. And what has happened is we have, the capital markets have rewarded much more disruptors and new entrants to industries. And so it's just a different setup. I think what we're always to benefit from is our opportunity set because it's much more difficult to access. It requires a trusting relationship, it requires a time, and it requires a capability set and a toolkit that pretty much nobody else has in it. But with market, that is still available to us. It's deeply available and Japan and it's deeply available, I think, everywhere. But I would not say we're in the quote unquote golden age of activism because I've seen two golden ages. Yeah, come on. And get different tenors to that. I mean, I like very much this distinction that if I think about three years, obviously, a great group of people, but they were very focused on the cost structure of whatever company they were taking over. Okay, the cost structure is here. I can bring it down a little bit by doing x, y and c, by adopting best practices that are here in this side of the company and exporting those best practices to that other side of the company. And it is true that in many of those great operations, and there's several upgrades for a lot of the wonderful things they did, there was less of an emphasis on this strategic outlook in the context of transformation, disruption, and so on and so forth. It was really an effort at rationalization of the cost structure, almost kind of assuming a constant investment opportunity set, whereas it seems to me that value act is, we're going to focus on the future. These companies are good companies. Well, run them and we're talking about Microsoft. We're talking about Olympus. We're talking about companies, decades of corporate successful corporate history behind them. And they just need to position themselves to benefit from these particular ways of disruption that they've been subjected to. Is that how you see it, did I capture it? That's exactly right. When we talk about creating these 21st century global champions, we really believe there's a tremendous value to be created in investing in incumbents and helping them transform to these trends. That's our mission. That's what we get up every morning to do. And it does incorporate some elements of operational excellence, but it's a lot more than that. It is reimagining the value proposition. It may be shifting the business model. Like we talked about licenses, description, or it's making choices about where to play, which battles are winnable, which are not winnable. It's about becoming a talent-magnet for creative people. It's so much deeper than we can take your margins from 20% to 30%. It may have that as well, but it incorporates this sort of 360 degree perspective and all of the pieces are integrated. And I think that's a buzzword for us too, as sort of integrated versus separated. You have to kind of piece all of the Jekseh all has to fit. So then on that note, what keeps you awake at night and what makes you excited about the future? What are the things that worry you when you think about it? Do you think it to yourself? I wish that would go away. I would like to know the answer to that. Whenever you have that guilty, plush moment that you want to think about, that gives you super exciting trend that you want to be part of. I have complete conviction and confidence in the game plans that we have. One of the things that has been frustrating over the last five years is the vast sort of valuation of disruptors as opposed to incumbents. And our business has really achieved lift off. At the moment I wish there's a perfect feedback we've created between input and output of strategy and teams, accomplishments and the rewards in the capital markets because then they see that what they're doing is working and it attracts more talented people and it attracts more clients and customers because for a long time Microsoft is a great example. Overused this example, but it was not viewed as like the most exciting place to get a lot of work at Google or Facebook or somewhere else. And when it started winning again and that winning was manifest in the stock price, you created a beautiful flywheel of like this is one of the best places to work and build a career. And so at outset, we're doing something very contrarian when we invest in the company because it's usually not performing. And the feedback loop between sort of like input and output, we close these gaps quicker in the past than we have done recently where it's been I think a disproportionate reward of disruptors at the expense of incumbents. But time and again, we've proven that with the right insight and the right engagement and the right fact based and the right decisions you get there. Can we sort of get the spark plugs in this engine to fire so that the truck gets rolling up the hill? That's the thing that keeps me at the night. So it's a recognition problem rather than a mission problem. Very good. So we always finish these conversations with book recommendations. What is that you've read recently or what you have read in the past that led to strong impression on you? It doesn't need to be an investment book or anything like this. Something that you thought made a difference in the way you see the world yourself, your career. Something that you would like everybody to read, a couple of things that you can leave us with. I like drawing a lot in the world according to Garb is a really great novel about feminism in the 1970s, but as a father, it's a very, very good book about fatherhood and parenting and the anxieties and the journey that that takes you on and it covers a full lifespan of a person from birth to death and the different perspectives and outlooks that he has at each stage remains of the day as a similar novel where a man is sort of reflecting on his past and people that have worked with him. Oh, it lives an impression on you that work. It lives an incredible impression on you. Yeah, I agree. And I think this work can be as emotionally rewarding as it can be draining to you as you were working with you with these massive transitions of industries and stuff like that. So I find those novels which has recovered time and relationships very insightful on the human condition, particularly the remains of the day. It has an element of sort of like delusion and what I used to believe about a person or a thing that I've written versus what I believe now. There's a book that I read recently called Strategy by Lawrence Friedman, which is this history of military strategy. And at each chapter, I could map exactly its relevance to our work. For instance, it starts out talking about chimpanzee tribes. What happens is they'll be the Alpha Chimp and all the other chimps will support the Alpha Chimp and support the Alpha Chimp, support the Alpha Chimp until he is at the moment, which he is bested by the next Alpha Chimp, at which point they rip the Alpha Chimp limb from limb and dismember him and destroy him. And I said that thinking that is CEO succession right there because a sport will support and support and support and support and support a CEO, no matter through bad performance and bad scandal that until the moment it doesn't and then it will dismember and destroy the person's legacy reputation and elevate the next thing. And if you think that businesses run based on truly rational, economic, acting thinkers, think again because we're all just monkeys at the end of the day and we have, we are emotional human beings and that type of behavior is in us and it is how we operate. And it goes on and on their perilous for how Napoleon's operations and strategy are relevant all the way through the Gulf War and everything. So it's a big book but I would encourage people to read and think about not just this is an interesting recitation of strategy and tactics but this is actually something that is a metaphor for my life. Mason Morphe, Chief Executive Officer and Chief Investment Officer of Value Act Capital. Thank you so much for coming to the value investing with Lane's Podcasts. It's been quite a pleasure and wonderful conversation. Thank you so much. Thank you so much. It's been great to be here. Thank you again and to all of you. I will see you again in the next podcast and this has been the Value Investing, Lane's Podcast. Thank you for listening to this episode of the Value Investing with Legends Podcast. To subscribe to the show or learn more about the Hellburn Center for Graham and Dot Investing at Columbia Business School, please visit GrahamandDodd.com. Thank you.