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David Abrams, PCG & Teva Pharmaceutical

Within the small world of value investors, there are few people we look up to: one of them is David Abrams. He is the founder of Abrams Capital Management, a Boston-based fund with $9 billion in AUM.

A fun fact: At the start of David Abrams’ career, he persuaded his boss into buying a fifth of a company he thought was great. It turned out to be fraud. Imagine starting out like that…. The lesson you can take from this is: don’t think that the spreadsheets tell the whole story. The book value is just part of the overall situation, and you need to understand the actual company that you are investing in.

Recently I went through my folder of favorite interviews and discussion, and I found the transcript of one of the only public discussions that he has ever done. This was in 2008 during the Graham & Dodd Investing Symposium with Howard Marks and his mentor Seth Klarman.

Howards Marks is the co-founder of Oaktree Capital Management ($112 billion AUM) and Seth Klarman is the CEO of Baupost Group (~$30 billion AUM). An event in which these three individuals discuss their strategies is golden. I highly recommend you click this link to have a read yourself, it’s only 69 pages in length.

If you don’t have time, these are the most important points:

  • Stay away from bad people. They don’t change and you will waste your time. Just like that, there are cheap stocks that should be cheap because management refuses to change anything. When it’s that bad, just let it be somebody else’s problem.
  • Be cautious about leverage in the underlying companies of your portfolio, as well as leverage for your own investments. Leverage, no matter how small, in a bad situation, can let a company drown in a pond just one foot deep. Stocks can be cheap, but if they can’t deal with their leverage when it is due, you stand to lose.
  • Repeating our foot-deep pond analogy, it is important for investments to survive in the short term rather than on average in the long term. You can’t only maximize returns in great times, because you won’t survive the worse times.
  • Once again, I suggest you read the entire transcript here. It’s filled with valuable insights and lessons.

This segment is focused on David Abrams investments though. I want to specifically focus on two of his investments: Pacific Gas & Electric (PCG) and Teva Pharmaceuticals (TEVA), two positions I hold in my portfolio as well.

I bought into PCG in the third week of 2019, when the news was covering Baupost’ near $400 million unrealized loss on PCG. The market cap was about $4 billion, and the stock price fluctuated around $7-8.

The thesis is extremely simple: PCG is not going anywhere. They have a monopoly for the state of California. It was inevitable that they would file for bankruptcy soon to clear them from their liabilities. They have done this before in 2001.

Any additional costs that they will incur will just be passed on to the customers, who are already paying premiums versus state neighbors. But the best thing is, the price was less than $10 a share and following the bankruptcy filing, the stock was inevitable to grow again.

I planned on exiting this position, until March 18th happened. On that day, the announcement came that David Abrams is partnering with Knighthead Capital and Redwood Capital to reform the company. Although one is supposed to have a sophisticated thesis to hold on to a position, I simply felt confident with David Abrams being involved. I had more than doubled my money on this position, and hence placed a 35% trailing stop loss. I’ll periodically check whether it’s still worth holding onto PCG. As for now, I’m awaiting more guidance on the activist plan of Abrams and his 2 partnering hedge funds. Furthermore, I’ll also wait to see what David Abrams’ mentor, Seth Klarman from Baupost Group, will be doing. I’m expecting an announcement on this during this quarter.

The second stock I want to discuss is Teva Pharmaceutical (TEVA), a stock that David Abrams has held since Q3 2017. This was the quarter during which Kåre Schultz was appointed as CEO. In the 20 years of his executive career, Kåre never m issed guidance.

Teva stock has been in trouble since their acquisition of Allergan for $40.5 billion in 2015. They were $35 billion in debt, which has now been reduced to $27 billion. The new CEO is very active on cost cutting and has let go of 10,000 employees and reduced annual costs by $2 billion.

The stock is trading more than 80% below their 2015 highs. Their current market cap is just over $54 billion. The charts are telling me that there is further downside ahead, but we’ll soon reach a bottom. As any investment right now would be going against the trend, it is wise to start out small. The fundamentals show it is undervalued, so I’m expecting a potential turnaround in the coming months.

In the email from January 20th I wrote a more in-depth analysis on Teva, so please find those emails if you are interested in investing.

Note: Warren Buffet owns 43 million shares of Teva Pharmaceutical.

The other stocks that make up most of David Abrams’ portfolio are Franklin Resources (Ben), O’Reilly Automotive (ORLY), Lithia Motors (LAD), AMERCO (UHAL), Willis Towers Watson Public (WLTW), Facebook (FB), Kinder Morgan (KMI), Alphabet (GOOGL), Asbury Automotive Group (ABG), and Pacific Drilling (PACD). He has a few more investments in his portfolio, but those are all for less than $100 million each.

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