Narrowing The Spread
In merger-mad Wall Street, Mario Gabelli may be madder than most: Certainly the 43-year-old money manager has made his reputation as an expert spotter of candidates for takeovers, leveraged buyouts, mergers, or liquidations. Gabelli, however, doesn't wholly fit the stereotype of the paper entrepreneur whose only concern is the fast buck. Rather, he invests with an eye toward undervalued assets -- and to factors that will "narrow the spread" between what he has to pay for the assets and what he thinks they are worth. He looks, in short, for companies that have built good, solid, unglamorous businesses, which are at some kind of turning point in their corporate lives.
Gabelli began his career as a research analyst with Loeb Rhoades & Co. When his next employer, William D. Witter Inc., merged with Drexel Burnham Lambert Inc. in 1976, Gabelli opened up shop for himself. "I didn't know how I was going to get paid," he says now, "but I knew one thing. I knew how to make money for clients." So far, the record bears out the boast. Gabelli's GAMCO Investors Inc., which manages a total of $700 million for individuals and pension funds, racked up a 29.9% compounded annual return for the past five years.
INC.: Takeover artists like yourself have reputations as quick-money artists. Do you like to get in and out fast?
GABELLI: I have to make 50% in two years on any stock I buy. Any longer than that is too long, any shorter is too short. I go belly-to-belly with management, see the competition, the plants. To do this with an industry or a company takes anywhere from six months to a year. If I shoot for a 50% total return over two years, that translates into about a 10% real rate of return per year, given taxes and inflation.
INC.: When you do your initial research, what are you looking for?
GABELLI: We sit down and figure out what a businessperson would be willing to pay for a company. That is what we call its private market value. We evaluate the assets by stripping them down into little tiny pieces to determine what the business is worth. We buy asset-rich companies that are selling at a fraction of their real value.
INC.: Any old asset-rich company?
GABELLI: We want one other element: a motivated seller, someone with a reason to sell the company. Say we pay 60? a share in the public market, and a dollar is what we have analyzed it to be worth. What can narrow that spread? It can narrow by takeovers, either friendly or unfriendly, or because the company decides to go out of business. It can narrow with a leveraged buyout. Or it can narrow by a corporate restructuring, which is what Litton Industries and ARCO have done. We speculate that Gulf & Western Industries is going to do that, too.
INC.: What industries do you nose around in?
GABELLI: We buy mundane businesses that I understand: salt, broadcasting, auto parts. One of my favorite investments was crayons -- Binney & Smith, which was acquired by Hallmark Cards last summer. When we first started recommending the stock in November 1977, it was $11.50 a share. Hallmark bought Binney & Smith for $56 a share. The company was technologically stable. It had been around forever. My kids used their crayons. And I knew I had nothing to worry about from competition when I went to see a competitor of Binney & Smith. It was the first time that management fell asleep during my interview. Literally. Another mundane business I follow is Earl Scheib Inc. I started following Earl Scheib in 1968. Like Binney & Smith, which for years kept the price of a box of eight crayons at 15?, Earl Scheib painted any car any color for $29.95. Now, with inflation, it costs $99.95. Earl Scheib is an example of what we call octogenarian plays. These are capital and management succession questions, which sometimes provide the element we refer to as a catalyst.
INC.: Say more about catalysts.
GABELLI: A catalyst is a visible element that can cause the spread between 60? and the dollar to narrow. With Earl Scheib, Mr. Scheib is 77 years old. Of the three directors who are standing for reelection, two are 82 and one is 75. The Scheib family owns 44% of the stock, and I think at some point in time, they will have to sell.
INC.: What other types of catalysts flag your attention?
GABELLI: Catalyst number one at Gulf & Western: Charlie Bluhdorn, who was chairman and ran it as a personal holding company, died of a heart attack. Catalyst number two: Marty Davis, who is now chairman, is selling off Gulf & Western's consumer and industrial divisions. We are watching to see what he will do that will be in the shareholders' best interests. [In August], Gulf & Western announced that Wickes Cos., which just emerged from Chapter 11, closed on a deal to buy out these areas. That's why we want Gulf & Western.
INC.: You don't follow high-tech stocks, but do you follow companies with capitalizations smaller than the Gulf & Westerns of the world?
GABELLI: We bought around 50,000 shares of a company in Boston called Tech/Ops, which has 750,000 shares outstanding today. They provide a badge that detects how much exposure one has had to radiation. The Landauer Division [R. S. Landauer Jr. & Co.] of Tech/Ops is the dominant factor in a business that is growing at 15% annually. I think the business of monitoring exposure to toxic substances will be a great one. They know how to do it in a low-cost way, and they are good at it.
INC.: Given your interest in narrowing the spread between market value and underlying value, company managements must sometimes perceive you as a real threat.
GABELLI: We are lambs in lamb's clothing. We will do nothing unfriendly. However, if management does something that is stupid and against shareholder rights, and we own shares of the company, quite honestly we have to tell them where they are wrong. If they are persistent at folly we have to take action.
INC.: That doesn't sound entirely lamblike.
GABELLI: Occasionally, we get into activist confrontations. We believe we are owners, and we act like owners. We get annoyed at managements that do dishonest -- intellectually dishonest -- things. Their motivation is to protect their asses and save their jobs.
INC.: Who are your investors?
GABELLI: Entrepreneurs are attracted to us because our approach is entrepreneurial. We have no wiggles on the charts, no technical readings. We are buying a business. If we can buy it cheaper because the price of the stock has gone down, we're happy.
INC.: And is your investment performance as good as ever?
GABELLI: Our rate of return on client accounts has averaged 27.9% compounded since we went into business in 1977. Last year, in an up market, we were up 18%, but inflation was 4%, so we made our clients 13%. This year we are up over 20%. If the market is going straight up, you don't need me and I get nervous. If the market is going down, it gives me an opportunity to accumulate a lot of stocks cheaply. I like down markets.
INC.: Other than the companies you have mentioned, what are some of your current favorites?
GABELLI: I think money will be made in Rollins Communications. The company has been public for about a year. They own three television stations, cable TV, and outdoor advertising. Currently, the stock is 25. In two years, the private values are over 40 -- and I think Mr. Rollins, who is 74, will not be running an independent company.
We also like Warner Communications at 29 1/2. It's a creative company with a critical mass in the record business, which we think is making a terrific recovery that will be sustained. The combination of MTV, new sounds, and less fragmentation of the consumers' dollars by video games will help Warner.
INC.: Do you personally invest in areas outside of your business?
GABELLI: As a limited partner, I have personally owned television stations, outdoor advertising, oil and gas, R&D shelters, and real estate. I don't mind putting a small amount of my current income into those kinds of transactions, but I have just never done well with them. I will give you everything I have ever invested in outside this business for 20? on the dollar. I am notoriously unsuccessful at anything outside the equity markets.