Tom Russo at European Investing Summit

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Thomas A. Russo
Partner, Gardner Russo & Gardner

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Exclusive Transcript
(lightly edited, may contain errors)
Thomas A. Russo, Partner, Gardner Russo & Gardner
“How to Invest in Europe — A Superinvestor Perspective”
European Investing Summit 2012
Host: Welcome back everyone, to this live keynote session at
European Investing Summit 2012. We’re very excited about this
one. This session came about last minute but we’re just very
flattered to have with us Tom Russo. I’ll let Oliver properly
introduce Tom. He will then share his remarks with us. After that
we’re going to have a Q&A session. As always, feel free to write
in your questions at any time into the online interface. This
session is being recorded and will be available in the online
conference area within 24 hours. And with that, Oliver, please go
ahead.
Host: Thank you, John. We are very fortunate to have with us one of
the world’s greatest investors, Tom Russo of Gardner, Russo
and Gardner. Tom is a global value investing heavyweight. From
his early days at the Sequoia Fund in the 1980s to now

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overseeing $6 billion of capital through separately managed
accounts and Semper Vic partnerships. Tom has had the
foresight to recognize the benefits of international investing
before many other investors and has so skillfully executed on this
approach. We are very delighted he has taken time out of his
schedule to be with us today, to update us on his latest thoughts
on Europe and beyond. So without further ado, Tom, the floor is
yours.
Russo: Thank you very much, Oliver and John. I am delighted to
participate. This is the most high tech thing I’ve ever done. I think
my two children—in their mid to late 20s—will celebrate the fact
that I have been involved with a webinar and speaking indirectly
through not only an online version but also through this
conference. So it’s exciting. And I have had the great pleasure,
really from my Stanford Business School days when my
professor, Jack McDonald, suggested that Americans are far too
provincial as investors and they should in fact look abroad where
95% of the world lived, even though back in the early 1980s the
investment market of global equity values were concentrated so
heavily in the US. The promise was all abroad even then and I
had the good fortune of having someone I admired steer me that
direction. In the early days—very tough to do. American-based

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investors were quite skeptical because the US market seemed to
be certainly sufficient in terms of the returns that were possible to
get and there are two expressed concerns, which since they last
to the present they’re probably worth expressing.
Early days people worried about accounting and they said, “How
can we trust the accounts?” and at the time, for instance, when I
first started to buy Nestle [Swiss: NESN] in 1987 the semiannual
report was only four or five pages. It was very scant. But it gave
you the important information and with the culture of the firm
being on course and the annual reports being disclosures
sufficiently deep the midyear didn’t seem a problem. To me what
it meant that an ADR facility couldn’t be established and people
avoided the stock because they didn’t get American style
accounting—that was to their discredit. And over the years we’ve
seen that the greatest mistakes and frauds have been often
American accounting based frauds. So accounting was a
problem for investors but I was able to comfort myself with that.
And the other expressed concern was “What about the currency
risk?” and my answer then and now remains “As compared to
what?” because as an American, if you consider foreign
currencies to only be a source of risk it’s a fairly ethnocentric way

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of viewing the world and there are elements embedded in QE3
today at the most extreme but over the past several decades
there have always been elements that led to lower dollars over
time and I was prepared to accept the risk of the opposite back in
the 1980s and we’ve been benefited by having foreign exposure
over time.
Fast forward to today. The question becomes “What’s the value,
particularly in the European companies?” and the context seems
so horrible with the collapse of the euro imminent and with
sclerotic economies but I’ve found that amongst the companies
that we’ve owned over time the European companies have done
a great job often in the thing that I find to be one of the biggest
risks, which is the risk of agency costs. We’re able to find in
European companies often family controlled companies where
managements are incented to take the long view and the
companies are able to turn down the quarterly earnings noise
more forcefully out of the European based than American
counterparts enjoy where the drumbeat for quarterly estimates
and meeting them is much deeper. So in Europe the lack of the
option compensation culture has meant that the urgency with
which projects yield results has been lessened and so historically
the businesses have had less option pressure.

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Many of our European businesses enjoy the fact that they had
already gone abroad decades ago with the empires so Cadbury
was in that position, Hindustan Lever’s presence is shared by
Unilever [London: ULVR], but those were part of the early British
influence in India. All over, European companies have been
involved with Africa far longer than American businesses ever
were, so there is a brand preference that’s a legacy that we’re
able to patch into. I think that’s been very helpful as those
markets have grown under the recent past. The brands that were
embedded are those that are aspirational and our businesses are
able to reinvest behind developing those brands for the market.
And so we have a fair number of European companies with such
global brands and embedded presence abroad.
The other thing about the European situation at the moment is
that there is such global pessimism that there is little regard
given for businesses that have succeeded in Europe for the long
term. In fact there is some burden that comes from that. I think of
two portfolio holdings—Heineken [Amsterdam: HEIA] and
Nestle—who are often censured by investors because they’re so
heavily present in Western Europe and that’s deemed a burden.
But over the past five years operational gains have come that

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have long been needed but unavailable in Europe. Nestle, for
example, having owned Perrier—a French based business—for
so many years and unable to get needed work relief, over the
past couple of years has had labor relief sufficient to give them a
chance for enough profits from that long staggering division that
they’ve invested heavily behind brand marketing and now the
brand’s growth rate is up into the low 20% range and with that
are finally coming profits because the cost structure has been
modified and that was something that did not happen willingly but
it happened under Sarkozy by virtue of the fact that there is just
so much pressure on France to become more market effective.
I’m not sure how that will develop with the new leadership in
France but it certainly was an example of how progress was
made. In England, for example, Heineken has closed four
breweries and they actually share production of their beer now
with some other breweries in England to try to get best cost. And
so even though there is a fear over sclerotic Europe, the
businesses that we have who run there are able to run more
effectively, harnessing technology to be more efficient and also
by work changes that have allowed for best practices. I am just
back from a visit to China where I met with management from
Nestle who wanted to showcase their involvement with this

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important growing market. It’s part of the fear today in global
investing is the slowdown in China and at the level of selling
Nescafe coffee or Chinese-sourced confectionary or Chinese-
sourced beverages like peanut milk one would see a fairly robust
and vibrant market when you tour. The arrival of western style
retailers is helping the business to become more effective and
more efficient.
The willingness of Nestle, in their case, to use local joint venture
partners means that they’re able to harness the insights about
the local consumers’ tastes but deliver to those businesses the
kind of world class production and accounting and operational
structures that Nestle has mastered elsewhere. So it’s a positive
relationship but they do retain local owners and local managers
in a very high and elevated way, which is a change for Nestle as
they try to gain greater share in this fast growing, important
market.
And the general level of business as I saw it—at least at the
consumer side—remained quite active and there is still a great
buzz on there. China, on the other hand, confronts a power shift
and there are certain adjustments that are coming about because
of that. There is a huge amount of chest beating over the

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controversial islands between China and Japan, which is venting
a lot of past grievances and it’s not clear how that’s going to work
out. I also met with Brown-Forman [BF] management and they
have a traditional effort to try to gain access to the extraordinarily
large Chinese local spirits market and there are modern
developments that are happening as the western competitors for
spirits become less dependent on key retail and are opening up
their business to the consumer more broadly as the off premise
and the less formal trade develops in China for spirits and
Brown-Forman is addressing that through their Jack Daniels
brand and some other products that they’ve developed for the
market.
Most of the global businesses that we own in the international
markets—Heineken, Nestle, Unilever—they typically have local
shareholdings available to local investors in many of their key
markets. I was accused by one of my former colleagues of being
a “sissy investor” in the international world by buying the
multinationals. Some people on the trip to China were celebrating
the fact that you can participate in the local markets more
forcefully by buying shares of their local subsidiaries—and we
can talk about the thoughts behind that. And the valuations for
businesses like those I referred to are not cheap. They’re low to

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mid teens multiples of next year’s earnings. Those earnings are
slightly burdened by reinvestment spending to develop the future
platforms. But in general they’re not at compelling crisis
valuations anymore but the capacity for the reinvestment to go
on for a long time and the ability to address large, open spaces in
the marketplace—the growing population, the rise in GDPs and
the rise in consumer disposable income—mean that I think that
the businesses can earn their way into the current valuations and
with that I’ll open up the floor to questions.
Host: Tom, thank you very much for those remarks. I want to remind
everyone that if you’d like to ask Tom a question feel free to send
it in through our online interface. We do have questions coming
in fast and furious here. There is one from Joe Koster who is a
very thoughtful value investor in his own right and he writes that
at a presentation in Omaha in May Bruce Greenwald mentioned
how Nestle is the perfect hedge for either inflation or deflation.
Based on your comments today and in other places I assume
you probably agree. Can you give any examples of other
businesses that can thrive in either an inflationary or deflationary
environment and is pricing power the overwhelming
characteristic to look for in identifying such opportunities?

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Russo: Pricing—well thanks for the question—pricing power is really the
result of the company’s total process of delivering products that
have attributes that they determine the consumer wants
sufficiently, that the consumer believes there to be no adequate
substitute. And that really is the job of the companies that we
invest in is to capture deep consumer insights so they know the
needs that they then can address through rapid innovation of
products that offer the ability to meet those consumer needs. And
that’s what we look for and as a result of that the consumer
believes that there is no adequate substitute for the products that
our businesses offer and they’d be willing to bear a little higher
cost as a result of that if costs indeed must go up to face inflation
pressures and cost of goods sold.
Nestle prominently describes their efforts to tap into the
developing emerging market through something called popularly
priced products and usually that means reformulated products so
that the cost to deliver a Nescafe coffee at the earliest stage of
consumption in developing markets is going to be lower because
the product is reformulated. It had different attributes and so they
can deliver it in an expensive channel to market with sufficient
margin because they often reformulate the product.

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As far as affordability, the products come to market in one or two
serving packages and so the consumer, at the early stage, can
afford it because the product portions are small. And so they can
afford it. There is margin built in. The cost structure is modified
because they reformulate the products for the market’s needs.
And that’s how you can survive the rising potential costs of
energy for distribution or ingredients for the manufacturing.
In terms of deflation I ascribe a fairly low amount of time worrying
about that because I don’t see how we’ll get that over time and
so our businesses are more possessive pricing power to offset
the growing costs rather than holding onto their prices during a
time of declining costs. So I’m not as schooled on deflation and
what it will mean for a firm like Nestle as Bruce is, but the real
driver for Nestle is going to have to be the migration from
popularly priced products up the pricing ladder to products that
have more attributes and more value delivered and that comes
along with the rise in GDP and consumer disposable income in
the developing markets where we are at.
The deflation—that might occur and it may be more western
European and more developed market deflation matching the
weakness in those local economies and in that area the

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companies have to be able to focus on cost management without
any abatement whatsoever—a ferocious focus on cost—and
there, technology plays such a huge role. And our businesses—
at the best level of operation—are putting out best practices that
are run through SAP systems and system wide operating
systems that allow them to operate in developed markets where
pricing pressures placed on them by retailers and deliver
products that are manufactured with less operating cost and
that’s the return to technology investment that our businesses
are making.
Host: We have a question from Dave Sather who writes some family
controlled businesses are good stewards of wealth while others
are not. You don’t seem to be scared away by control families.
What characteristics do you use to differentiate between good
family control versus bad family control?
Russo: One of the great indicators is the caliber of the people who are
not family members who are active in and retained by the
businesses that we choose to invest in. It’s really clear if you
have a business where the family is abusing the franchise for
whatever reason, whether they’re underinvesting, whether
they’re siphoning off money, whether they have side deals with

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themselves to pay themselves premium for services offered or
products delivered. They have ways in which they extract value
from the public. Quality individuals tend not to find a way to those
businesses. And so as you meet the various professionals up
and down a business if you feel like there is just a B-grade
quality to that organization it often reflects problems at the top
and problems within the ownership. So I think the real best test is
“Are they able to recruit the industry’s best and brightest and
keep them, incent them and then have them develop products
that are world class?” I think that’s certainly the standard that you
expect for a company like Nestle and some of their global
counterparts, if they haven’t had the right nurturing environment
or they treat their consumers with less attention than the
company that operates it at Nestle’s level, they just won’t keep
the same talent.
Host: Tom, another question from Dave Sather is what is the attraction
or deciding factor why you seem to favor Heineken or SABMiller
[London: SAB] as opposed to Anheuser-Busch InBev [BUD] or
Brown-Forman over Beam [BEAM]?
Russo: Well, one of the answers to that question in some ways involves
the benefit that accrues to an investor who is long only. I have

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great colleagues in the investment business who are long-short
advisors and often there is a pressure to identify the best and the
worst in an industry group and so in that environment kind of the
good may fall out because they’re not necessarily really bad or
they’re not great and so they’re not reviewed so carefully. And for
me, if I can find businesses that are generally great—and there
are a host of different companies that compete in it—I am
perfectly comfortable owning all of them. I don’t tend to own all of
them or many of them, at least at the same percentage weights,
and so the balance between the percentage weights has to do
with valuation and strength of the franchise and the quality of
management. And so that evolves—those portfolio holdings go
up and down in weight depending on what the market does and
depending on what kind of measures the companies do to
advance their business.
I didn’t have any holdings in Anheuser-Busch, for example, even
during the years when I owned SABMiller and Heineken and
Guinness for a concern over the quality of what the company
under the family was able to deliver off that great franchise and
made an investment in the business once I spent time with the
management that came in from AmBev and InBev, given what I
learned from them was their capacity to make the right

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investments to grow the business in those top five beer markets
around the world where they had dominant positions as a result
of the acquisition and it was a smaller position. It’s no longer…
It’s much more meaningful. It’s grown as I’ve grown comfortable
with the work they’re doing in markets and as the industry
consolidates there are some growing rational attention to the
need to make money in markets where previous managements
may have been more focused on something as unrewarding as
just plain old market share and they fought over bragging rights.
The teams increasingly in the business today are fairly return on
capital minded and I’m comfortable having a variety of different
exposures to the business because they all have areas of
specific strength that often are not overlapping.
Host: Thank you Tom. Our next question comes from Christoph Stahl
who is joining us from Munich—and by the way, what a
wonderful way to have a conversation with fellow value investors
all around the world. We literally have people on the line from
every continent. So Christoph asks, leaving aside valuation,
which would you consider to be the best alcoholic beverage
company or type of company—beer, wine or liquor? And would
you then rather wait until you can add funds to this best company

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at a fair price or invest in some other but cheaper company at a
lower price?
Russo: In terms of capital allocation, I’m fairly agnostic between beer
and spirits but have almost no direct exposure to wine as a
category. I’ve always felt that the value add off of the commodity
cost there and the pricing power that they enjoy in the wine
industry just hasn’t been as rewarding as you get with spirits and
with spirits increasingly where you can tier the pricing so sharply
and aspirational consumers are willing to pay substantially more
for components in the price hierarchy that don’t cost all that much
more. And so there’s the possibility of tiering in a way that you
really just don’t get with wine. And then beer compared to wine—
the economics of beer at scale with dominant local brewers is
just far more attractive than you ever find with wine because of
the great production efficiencies and the scale advances that you
get with brewing as opposed with a wine gathering and
operation. So I prefer spirits and beer over time.
A great business, which I’ve appreciated more fully with the trip
recently to China, is the very high end competitors in China’s
enormous spirits business. They have the capacity to charge, I
think, for a 150 year old bottle of Maotai 38,000 renminbi and the

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kind of brand loyalty and packaging innovation that they have in
the high end local market in China is quite impressive. We have
businesses in the West that I think are doing excellent work and
our portfolio includes in no particular order but all terrific—we
have Diageo [London: DGE], Brown-Forman, Pernod Ricard
[Paris: RI]—there are a host of other spirit companies that are
quite attractive as well, which we constantly consider. Beam I
have not had any investment in. I’ve tracked it. They’ve had
some terrific recent success with some products.
I think for me, to see pricing restored on their core Jim Beam
brand would be very encouraging as that unusually large
business for them has had a history of lack of confident pricing
and the category of bourbon ought to enjoy confident pricing and
that would be something that is important to see in Beam’s case.
But the industry is well represented and there are lots of
businesses that we have not yet invested in the spirits industry
that are very attractive and it’s just going to be a question of price
and getting to know management better.
Host: Our next question is from Simon Denison-Smith of Metropolis
Capital, who by the way hosts the wonderful London Value
Investor Conference and he asks that value investors often

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describe a strong brand as a moat. From our perspective, a
strong brand does not always seem to give a company pricing
power. Do you agree with this and how do you determine when a
brand does cause a wide moat and when it does not?
Russo: I think the real story with brand strengths and the return that you
get from them is linked to the distribution and the retail channel.
And to the extent that you are reliant upon the mass market
where the retailers have enormous clout and you fail to deliver
innovation on your brand platform, you are increasingly today
going to suffer pressure on price. And so it’s really incumbent
upon the stewards of the brands that we invest behind that they
innovate and that they add value and that they tell the consumer
about it through effective marketing—whether it’s digital, whether
with conversation or whether it’s broadcast, whether they create
an atmosphere, whether it’s billboard—whatever the vehicle is—
they have to tell the consumer that there is a reason why they’re
asked to pay up is because some product feature warrants the
premium price that they’re asked to pay. And absent that in the
grocery or the beer, spirits, wine are—absent that you’re going to
face pressure and the pressure is going to increasingly come
from the retailer and it’s going to be enforced against those who
fail to innovate by retailer owned brands, which increasingly are

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viewed as adequate by consumers around the world when
compared against just the me-too offerings of even strongly
branded companies if they don’t add enough value through the
communication or the innovation that the product should deserve
to stay vital as a brand.
Host: Next we go to Brian Hetherington who is asking what are your
views regarding the strength of demand from emerging market
consumers for high end western brands and then have those
views changed at all recently?
Russo: I’d say the trip to China, which I just returned from, offered an
interesting wrinkle to the question that you ask. We flew out of a
second tier city airport on the travels between Shanghai and
Beijing and this is a second tier city which happens to have ten
million people living in it so the airport was extraordinary, brand
new and vast and as we traveled through the airport there were
just like in any American airport extraordinary large numbers of
retail opportunities and all of the stores looked like those that you
see at the new terminal at JFK. However, upon closer
examination as you walk by the stores, you would see that
instead of Prada the brand was Betchi [sp] or something, their
trademark and brand that accompanied retail venues at the

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airport that looked every bit as high end and as luxury as the
retailing offerings that you’d see in western airports. But they are
local names I had never heard of. That’s the first time something
that I’ve pondered, whether it would happen or not, that I saw
starting to develop, which is the rise of copycat local offerings by
brand. Relatively confident prices so that’s new and it’s
something worth keeping in mind and exploring.
And what else may have surfaced in the appetite for western
brands—I still think that the consumer around the emerging
markets where brands have been present for a long time but
unaffordable, when they have some incremental spending money
and that process of obtaining that is the rise in the GDPs that are
in many markets underway because the markets are being
developed for the first time in Africa, for example, as the source
of resources for China and the trickle down effect of jobs created
has growing numbers of people first time ever able to consume—
well they like the western brands that have been around but
unaffordable and that’s what they choose. And I think the
companies that we invest in have a duty to make sure that they
continue to have that initial instinct and then satisfy them by
offering the product with a compelling entry price, with
formulations that suit the market—in many instances that suit the

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market particularly in a way that delivers health and nutrition or
some kind of added value.
And with that in mind, across the continents I think the western
brands still have a role to play, at least as the countries move
forward and then they have to be careful in markets like China to
make sure that their products remain vital enough that the
copycat local brands at high prices don’t start to develop a
following that doesn’t refer to the western styled products that
they imitate. So it’s two different answers—one for the
developing market and one for the developed markets like—
increasingly developed markets—like China.
Host: Tom, a slightly more technical question from Matt Goetzke who
asks what discount rates do you use and how do they vary by
country or business when evaluating a new opportunity for
purchase?
Russo: I would say that the discount rate is sort of 10%, which is
completely irrelevant to today’s interest rate environment. It
historically had been sort of the long-term treasury rate plus a
risk premium but it’s also the hurdles that I believe equity returns
ought to be able to generate for investors. So it’s consistent with

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what my belief is—is that equity investors ought to expect over
time, over market cycles, and have double-digit returns to
warrant the risk that they take. And so the discount rate I have in
mind when I look in companies is still far higher than it ought to
be in some ways, in light of the very low nominal rates that exist
today.
Host: We next go to Giulio Battisti who is asking what’s the very first
factor or parameter you look at when you analyze a company.
Russo: Well for me it would be the people. It would be who owns it and
then it would be kind of who runs it, what’s the quality of the
management team—it’s very much people driven analysis. On
the ownership side is if there is a strong holder who is likeminded
in their long-term outlook I would find that to be a very early
positive indicator that justifies setting out to do more work. If I
found on that first test that there was something about the
management that left me feeling it was opportunistic or short
term driven I probably won’t embark on the analysis that follows.
Threshold screening would be caliber of owners and then the
management that follows.

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Host: And Pablo Gonzalez asks which method do you use to actually
estimate and arrive at intrinsic value for a company?
Russo: I would tend to think of the business as relative to the private
market values that exist and are knowable through transactions
that take place. That gives me a sense of what alternative buyers
would pay for a business and that’s kind of a mathematical base
case place to begin. I then think about the business and I think
about whether we’re priced anywhere close to that number, and
if we are perilously close to that number I’d probably pass. If
there is a sufficient discount from that what we would then end
up doing is projecting out what the regions in a business are
capable of generating and in that regional analysis or else the
line of business analysis—the segment analysis—you end up
with portions of the business that can grow far faster, can receive
far more capital.
We pay most of our attention into coming into businesses where
there are regional or product line growth rates that are
determinable and are substantially high enough to justify a
valuation premium. And so most of the analysis is spent inside
the segments to figure out where the greatest opportunities are in
a business. Then value the segments independently and come

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up with a sense of whether the overall valuation is in the
marketplace sufficiently below the value that you get from
analyzing the segments to justify the investment. And then the
power of being able to invest behind those segments or those
geographies is not available across all companies and so we pay
a high tribute to businesses that have that capacity.
Host: Thanks. I want to just go to Oliver real quick. I think he has a
specific question and then we’ll continue with the questions that
have come in.
Host: Tom, last time we talked it was at the time of the Berkshire
Hathaway meeting. I’m just curious if you could update us all with
your latest thoughts on Berkshire. The stock is up a bit since
then. What are your latest thoughts?
Russo: I have been very impressed by the increased confidence
expressed by Mr. Buffett towards his team of analysts and
portfolio managers who now work inside of Berkshire with
portions of the capital. A substantial increase in the capital
allocation suggests a confidence in their ability, which I am
delighted to see. The increasing potential for the advisors to
participate in different aspect of Berkshire, which has been

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referred to by Warren’s letters, is very encouraging. Berkshire
Hathaway’s annual report suggests that they’re involved with
operating divisions as they contemplate acquisitions. They may
be involved with some of Berkshire’s own acquisitions at the
corporate level.
That capacity is very, very valuable and if it surfaces to the work
that’s being done by Todd Combs and Ted Weschler we will be
far better off as Berkshire shareholders as they prove up that
capacity because it will in a large measure indicate that the ability
for Berkshire to continue to reinvest its float in growing operating
cash flows at high rates of return will be better off over time as
those two mature into greater and greater responsibility. That, I
think, is terribly important and to the extent that each are involved
with guiding the subsidiaries as to how they might consider the
acquisitions that they contemplate or the capital prices that they
contemplate—that will fill a capacity I think that’s been so long
well served by Warren Buffett. So the development around this
capital allocation process I found to be most encouraging.
Host: Konstantinos Mihalopoulos is wondering whether, Tom, you’ve
looked at a lot of companies in India or spent much time thinking
about investment opportunities there. How do you view the

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investment environment in India, especially with many family
managed companies?
Russo: Well, it’s a very good question. There are family managed
companies there and we have both spent time in India with
meetings involving our global companies that wish to showcase
the promise of their local market presences in this enormously
important market for future growth. So I would say that I
approach the market with extraordinary amounts of enthusiasm
for what our multinational companies will be able to do there over
time. They struggle to get land base in India that’s certain and
predictable because the bureaucracy is fairly impenetrable and
the infrastructure is very difficult.
But if you talk to the people at Philip Morris International [PM]
they are moving forward with plans on how they can participate
in that market where the vast preponderance of tobacco
consumption is done through products that are not western and
yet the market has an appetite for western sales products and
Philip Morris is trying to enter the market in a way that can deliver
against that promise of the products more expensive and so it
requires rising GDP to afford the products that Philip Morris will
offer but they’re working towards that. Heineken has a 40%

Thomas A. Russo



interest in United Breweries [India: UBBL]. That business is still
nascent.
The average Indian consumes less than 1.5 liters per capita of
beer. They like beer. It’s a problem with the regulatory
environment. At some point not far back there were only
something like 15,000 licensed beer distributors in India. It was
an extraordinary number to think about. There is probably that
many on the Upper East Side of Manhattan so it’s an opportunity
for both Heineken through United Breweries and SABMiller
through their own direct holdings in India to have a very strong
business over time and they’re investing behind it and I’m excited
about the prospects there.
The spirits companies, I think India may be the fourth largest
market already for Pernod Ricard around the world. It’s
extraordinary given the amount of restrictions that they face
bringing in the products that the consumer most wishes in that
market, which is made in Scotland whiskey. It’s a whiskey
market—India—and they—Pernod—has done a fine job
competing in that market as has Diageo in the local spirits market
and increasingly in the premium imported spirits market.

Thomas A. Russo



But that share of the total Indian consumption is way too small
relative to what the consumers would prefer and it’s a problem of
bureaucracy and tariffs and quotas and barriers that over time
will lift. And I know both Diageo and Pernod Ricard are investing
a tremendous amount of money in advance of that happening to
develop capacities to suit the market’s appetite when it’s more
open. We can keep going but those four companies are all
important portfolio companies—five of them including Philip
Morris—and they’re all deeply involved with developing their
markets as best they can in a difficult market to tap into.
Host: Next we have an interesting question from Marc Heilweil who
asks are there consumer goods companies which you feel are
not differentiating themselves enough to withstand house or local
brands? He suggests perhaps Tiffany [TIF] overseas or
Kimberly-Clark [KMB].
Russo: I don’t think I can call out specific names. I think both those
companies—from my experience with them—have done a
particularly good job of developing their businesses abroad. But I
don’t have any particular examples. I mean there are categories
that don’t lend themselves well to margins generally speaking
and one of those categories has historically been dairy but we

Thomas A. Russo



have examples in developing emerging markets where portfolio
companies are adding a fair amount of value through dairy and
dairy-related products because they are a tremendous way to
deliver health and nutrition benefits to the developing emerging
consumer, especially to the young consumer, for instance
recognizing that the brain development at ages 0-2 is so terribly
important in the health of a country and milk, which is in the
western markets heavily commoditized in developing markets
with proper application of healthful ingredients, becomes quite a
good business for Nestle, for example. Pasta is a pretty
commoditized product around the world. There are a host of
products that even when they’re branded don’t command much
margin and our portfolio companies have been in those
businesses and to their credit over time they’ve identified them
and parted company with them. The frozen vegetables, frozen
fish, frozen businesses in general—many markets have been
poor and our companies have exited those.
Host: Next I want to go to Eric Fourmentin who is asking in an
environment where money printing is the rule for years to come,
is it time to consider some heavily indebted companies—maybe
companies that have long term fixed rate debt?

Thomas A. Russo



Russo: Interesting question. I would say that businesses that have large
amounts of long term debt probably have gotten themselves into
that position by virtue of the structure of their business and the
structure of their industry and so I probably would not chase that
as a preliminary screening as a good investment to make but I
would observe that there is something that was quite interesting
in a talk by Mary Buchanan at Columbia Business School last
week where she lamented that one of the problems in today’s
markets, especially in the industrial company environment where
she often finds value, has been the pension—the world of
pension fund liabilities and the sharp decline in interest rates that
have driven massively higher the pension and liabilities—have
created cash flow burdens for businesses that are forced to
allocate capital to make up the holes and define benefit
obligations.
And at some point that story will play out in reverse. Interest
rates will go back up and the amount of underfunding at low
interest rates will reverse and possibly even lead to overfunding,
in which case businesses have asset values that might accrue
based on a change in that environment. She mentioned that it’s
something that is hard to contemplate at this moment because
the direction has been so decidedly downwards sloping but may

Thomas A. Russo



on reverse be an area of important development. And that is
something I would consider as important—heavily indebted
companies would so often get there by virtue of their own
industry dynamics, I may not screen for that.
Host: I think at this time we can take at most three more questions.
Tom, you have been extremely generous with your time. Is it
okay if we do three more with you?
Russo: Lucky three.
Host: Okay. Thanks.
Russo: Sure.
Host: So, Emmanuel Daugeras asks how do you decide that an
investment was a mistake. Are there any criteria you use for
that?
Russo: Part it’s the information that we get from ongoing contacts with
companies that lead us to realize that the businesses that are in
existence are different than those that we thought and I can think
back on Citibank, which we owned—and we owned it for a

Thomas A. Russo



variety of reasons—it was very global. At some point it was
considered the first national bank of the United States. When the
world’s currency crisis in the late ‘90s erupted there was a rush
towards Citibanks around the world for deposit security. It’s a
great global franchise. Sandy Weill owns several billion dollars
worth of shares in the stock.
We assume that he would be a forceful steward of our capital
because at the same time he owns shares just like we did. He
owned and paid up and that was his vast wealth and we
assumed that as close to the business as he was that there
would be supervision much like family controlled companies
enjoy. And it was extremely global and we were intrigued by that
and yet over the degradation that took place in the US capital
markets things arose that just didn’t seem right to us and would
constantly bid us back to the bank at some point we became
aware of the activities around the balance sheet called SIVs and
learned how they were struck and became quickly uncomfortable
with that feature and what it represented to shareholders and the
risks it represented. And so we left that investment. We were
lucky to have enough contacts with the company to come up with
that observation in time to exit before the bedlam ensued.

Thomas A. Russo



And so that’s what we do. We try to get that information from
meetings with companies and hearing… and then looking across
at other businesses that relate to it. And we received good
confirmation in Citibank’s case. We had an opposite example
when we held AIG [AIG], which was less successful and in that
case we probably believed management too late and too long for
their assurances that their derivatives books would converge
profitably over time and we failed to pick up from that process the
fact that they wouldn’t enjoy time because collateral posting
requirements would put them out of business in the meantime.
But it’s a process of just making sure that you stay with the
company and ask questions on the margin and listen to the
answers and look at body language and try to stay ahead of
adverse developments through that.
Host: I want to ask a question by Guru Prasad who is wondering
whether you look for companies with some of the characteristics
mentioned in the book Hidden Champions of the 21st
Century. He
says basically these are companies that hold dominant positions
in niche markets—so maybe a little bit smaller than some of the
multinationals. Could you maybe tell us whether you have found
some of those companies—leaving aside valuations for now—I

Thomas A. Russo



think he’s just looking for some quality companies that dominate
their niche markets?
Russo: I haven’t had the chance to read the book. I would say that in
general I always inquire when looking at niche companies that
dominate small markets what happens when those small markets
become bigger markets and when they become big enough to
warrant the entry of other competitors who can then come in and
disrupt the market dominance of an early champion like that
which you discuss. And I can think of two fields where this
question comes up from time to time and my caution over
dominant niche players exists and I’ll give you the one example
is the insurance industry where there are specialty grades of
insurance that are focused upon by certain purveyors because
they’re too small to be serviced by the big houses.
And I can think of the example of the bars and the entertainment
venue market in insurance being relatively specialized grade
where only people who understand the dynamics of that market
can really underwrite profitably, generally speaking, because
there are risks and exposures that are unique to the industry and
business is small enough that the majors don’t focus on it. When
business gets bad in say the hotel restaurant business for the

Thomas A. Russo



insurers they look over to the profits being made in the narrower
field that is specialty and they pour into it during the period of
time when the main markets are turning down and disrupt the
rates—the pricing environment.
And so a cyclical factor overwhelms the specialized niche nature
of that market every so often and the good news is in that
particular field is that when the majors finally get done with it they
lose an awful lot of money because they discounted the premium
and they’ve taken on risk that they didn’t even know about. They
can’t mitigate those risks. But it’s a cycle of boom and bust that
addresses even a niche business because of outside forces.
That’s one example.
The other example is chemical businesses. I am often told to
look at especially chemical manufacturers because they have a
niche product but as that business gets big enough it gets big
enough that a major chemical enterprise might covet the margins
and the now growing volumes sufficiently so that they apply new
capital to the markets to go in and try to seek some of those
higher margins from the specialty grade but the specialty grade
and the process becomes commoditized. And so I haven’t really
used dominant niche as a screening variable because of either

Thomas A. Russo



the opportunity for cyclical overruns like in the insurance side or
secular degrading that takes place when markets that are
specialized become big enough that they then attract competition
and they commoditize them.
Host: I want to end it with a question from Manuel Salceda, which I
think is a fitting question for this conference. It’s not an easy one
but I’ll ask it anyway. Tom, where do you see Europe in ten
years? Do you still see it as a group and thriving? What’s your
outlook?
Russo: Typically where I operate as an investor is I am an incrementalist
and so I would suggest that those are great fears of significant
dislocations and transformative dislocations. I am generally of the
school that things that have been for a long time will likely
continue in roughly the same way for longer than most people
expect and so I guess I would approach that question with that
general view of life that you’ll likely see much of the same.
The differences in this case are that the whole world of Eastern
Europe is still part of the equation and it has spillover effects on
what’s going on along its borders. I think about especially
Poland, Romania, the Czech Republic and the disruptions that

Thomas A. Russo



those markets cause several of our companies as it relates to the
premium pricing that takes place in the market like Germany and
the alternatives for lesser prices coming in from those
neighboring countries.
I suspect over the next decade that those neighboring countries
may become more like the west as they enjoy some of the
benefits of their productivity and so may become more west-like
even in eastern and central Europe. That’s a factor and then we
have the question about whether the EU continues to expand or
not and you think about a country like Turkey or some of the
other parts of the world that might want in and I’m unclear how
that process will play out but across Europe in general—Holland,
France, England—I suspect that they will go through a fair
amount of turmoil. Certainly France likely will in light of the recent
elections and the changes that might or might not stick.
But I’d say ten years from now you’ll still have markets that look
relatively unchanged and much like what they’ve been and that’s
consistent with the way I sort of philosophically approach the
world in general and then how it shapes my view about investing.
I think the rest of the world will have much more transformation

Thomas A. Russo



and that’s the area behind which I think apply capital to
participate in over time.
Host: Well with that, if we did not get to your question please feel free
to go online into our conference area and ask it there. Tom, I
really cannot thank you enough for taking the time to address our
audience, to share your wisdom and insights. We appreciate it
very, very much. Thank you.
Russo: Thank you, John and Oliver, for the chance. I have just elevated
myself in my family’s esteem because I have participated in
what’s called a “webinar” and I think really this whole process
that you put together is fascinating and I hope that those who are
interested in the international space as investors continue to look
there because it’s really an area of promise and opportunity, at
least from my perspective. And the forum provides access to a
lot of people participating in the same field in many similar
fashions so thank you for the chance to speak and take care.
Host: Tom, thank you very much and good evening to all of you.

Tom Russo at European Investing Summit

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Tom Russo at European Investing Summit