Notes From Longleaf Partners' Annual Meeting

Last week, I traveled to Memphis to meet what you might call the Navy SEALs of the financial world -- an elite group that shuns the spotlight while performing incredible feats where others fear to tread.

Longleaf Partners' namesake mutual fund has outperformed the S&P in 84% of rolling 10-year periods since its April 1987 inception, turning $1 into more than $13. But unless you attended their annual meeting last Tuesday, you'd never know it.

How Longleaf's manager, the employee-owned Southeastern Asset Management, can handle $40 billion with such success, while receiving so little recognition, remains a mystery to me. I think they must like it this way, and I have two theories why:

  1. They want to emulate the underexposed, shareholder-focused managements of the companies they love to partner with, like Campbell's Soup's (NYSE: CPB  ) Dorrance family, or the Grahams's Washington Post (NYSE: WPO  ) .
  2. By resisting the urge to chest-thump, they gain long-term investors, as opposed to speculators lured by past performance.

If true, that last part has proved to be an undervalued asset. When the price of Longleaf's namesake fund plunged from almost $40 in October 2007 to less than $13 on November 2008, the fund's shareholders responded by adding net money to the fund.

That's unheard of in the fund industry, and it wasn't because Longleaf shareholders (like yours truly) were gluttons for punishment. It's because shareholders knew that if the fund went belly-up, Southeastern's employees would go down with the ship.

You see, Southeastern forbids its employees from owning stocks outside of the Longleaf fund family. And since equities are the primary savings vehicle for most, employees effectively bet their livelihoods and their personal savings on their funds' performance.

This is either incredibly foolhardy or very noble. (I prefer the latter.) But the bond this creates with shareholders, no doubt, put Longleaf in an ideal position to benefit from other funds' forced selling in 2008.

And that trust did not go unrewarded: Longleaf's namesake fund is up 146% from its low, versus 86% for the index.

What Longleaf's up to now
Readers may remember that I'm a diehard Dell (Nasdaq: DELL  ) bull and shareholder. (Heck, I even tried to persuade Oracle's Larry Ellison to buy the whole company.) Dell generates gobs of free cash flow, and holds almost half its market cap in cash, yet no one seems to care.

No one but Longleaf's Staley Cates, that is. When an attendee asked about Dell at last year's annual meeting, Cates responded with what was, in my opinion, the greatest oral defense of a stock in human history. Listening to Staley speak on Dell is what I'd imagine it'd be like to hear Coach K engage in a private conversation with Phil Jackson about basketball.

So I was eager to see whether Staley and Longleaf were still fighting the good fight on Dell, or calling it quits, especially since Southeastern is the largest owner next to Michael Dell himself.

The verdict: Still it in to win it. Not only does Longleaf still own the stock, but it's added call options to its arsenal as well, essentially levering its position. Dell call options and stock now make up 7.7% of the Partners Fund.

Meanwhile, Longleaf's latest quarry is Colgate-Palmolive (NYSE: CL  ) . Again, options are at play here: Longleaf has written a $65 put option and bought an $80 call option, a bullish strategy. Longleaf says it would love to buy Colgate at $65, but thinks the franchise could be worth much more.

For the small-cap fund, Longleaf's Ross Gloztbach amused the audience with the nasty language used by Wall Street analysts to describe department store chain Dillard's (NYSE: DDS  ) , and then explained why he sees it differently: Dillard's still generates tons of free cash flow, while the namesake family has shown a willingness to make changes.

During the Q&A, a shareholder asked why Longleaf picked Dillard's, as opposed to Eddie Lampert's Sears Holdings (Nasdaq: SHLD  ) -- a value investor favorite. Longleaf Chairman Mason Hawkins responded that he sees more similarity between Dillard's and AutoZone (NYSE: AZO  ) , which Lampert famously saved, than with Sears.

In choosing Dillard's over Sears, Longleaf is going against both Wall Street and many value-investing peers, including Fairholme's Bruce Berkowitz and Lampert himself.

But as any Longleaf shareholder will tell you, being contrarian is what Longleaf does best. And at least in the past, it's made them a lot of money.

Fool contributor Chris Baines is a value investor. Chris's stock picks and pans have outperformed 87% of players on CAPS. Chris is a shareholder in Longleaf Partners Fund, and owns additional shares of Dell as well. The Motley Fool owns shares of Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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