From the book Concentrated Investing: Strategies of the World's Greatest Concentrated Value Investors:
Siem Industries made numerous successful investments since it became a publicly traded company in 1987, growing its shareholders’ equity from $5.3 million in June 1987 to over $2.01 billion at the end of 2014, growing at a compound rate of 25 percent. Siem has been instrumental to the success for many of the company’s investments, being named as chairman of the investee company in almost every instance for the purpose of enacting the strategies he outlined. It is a testament to his hands on, industrial investment philosophy.
Siem on Valuation
Siem’s success in the oil and gas drilling and shipping industries points to an unconventional facility for identifying and valuing investment opportunities there. How does he find those opportunities, and what does he look for when presented with an investment? He has worked his entire career in oil and gas drilling and shipping, with a particular focus on offshore drilling and other services. His first investments were made in individual assets, and he was fully concentrated in each of those deals, investing all of his capital into a single asset. Siem argues that such a huge concentration of capital was warranted because he had done his homework. The downside risk, from his perspective, was relatively small because he knew the industry so well. He also notes that he was young and “didn’t have the experience to see all the potential pitfalls that come with age, and the problem when you have old people deciding is that you get the benefit of their experience, but also they may lack the courage at times.” He says that, though he didn’t have a lot of experience at the time that he acquired the Haakon Magnus, his first investment, he had spent all of his working life in the oil and gas offshore drilling industry, and knew it well:
I knew all 118 submersible rigs in the world by name, where they were, and their contracts. I came young into a young industry, so I had a very good grip and understanding of all the dynamics in this industry, and therefore the quality of my judgment was high. I saw it as a fantastic opportunity to put all my wealth and energy into it.
His view is that the best way to get the valuation right is to have industry knowledge that can only come from experience. This knowledge gives him context to understand how each asset develops, its earning capability, and the state of the market for the asset’s services. This leads to an instinctive valuation. He knows the market value and cost to replace all the vessels, rigs, and other hardware that he depends on as operating assets. He also knows the earning capability as a yield on each of those assets. Siem’s favorite metric for calculating that yield is the earnings before interest, taxes, amortization, and depreciation (EBITDA) in proportion to the investment or capital expenditures (CapEx):
It’s a simple calculation. It’s basically EBITDA in relation to the CapEx. And it’s amazing what that simple calculation can do. I always do it myself when I sit in boards, whether it’s Transocean or Subsea or smaller companies. Management often present reams of calculations, internal rates of return, and so forth. And I have been surprised at some fellow directors who say, “Yeah, the internal rate of return looks fine, and it’s better than our weighted average cost of capital, so let’s go for it.” But you need to examine the model’s assumptions. How is the internal rate of return defined? What is the residual value that you put into that calculation, for instance? That makes all the difference.
With an idea of the cost to replace each asset, its market value, and its likely EBITDA yield after backing out operating CapEx, Siem calculates the asset’s earnings power. He looks at what it is currently yielding, and what he thinks it is likely to earn in the future based on how he, and management, see the market for its services developing. He says that some of the best asset plays he has done have been based on no income at all. If he can find an asset that has been laid off—not operating—it will have negative EBITDA because the owners have to pay the layoff costs. Those assets can often be acquired very cheaply. His first, the Haakon Magnus, was such a deal.
Siem says that having a permanent source of capital provided by the public company has allowed him the requisite time to complete many projects. A problem for many investors in terms of expressing their own investment philosophy is that they don’t have this access to permanent capital. A source of permanent capital, whether his own money or that of Siem Industries, is dedicated for the long term and allows him to invest for the long term. He can think differently about an investment than another investor, like the more typical fund manager, who has two tasks: (1) to produce returns and (2) keep the investor base happy. Siem believes that his long time horizon has been central to his success:
Industry, by nature, is long term, and the fund management business, by nature, is short term. Financial investors come in and out: They can push a button any day and get out. The principal industrial investors don’t have that luxury. They have to think for the long term. I believe indeed the success of industry is that you always think long term, so even if incidents like mergers or takeovers cause you to be out in the shorter term, you take the long-term decision as if you were to be the owner forever, that is healthy for the industry, and therefore also for its shareholders. I think that has been the success of our operation.