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The Search for Owner-Operators

There is a difference between a manager running a company that is not his own and an owner-operated business in which the

manager does not need to report numbers to anyone but himself, and for which he has a downside. Corporate managers haveincentives without disincentives something the general public doesnt quite get, as they have the illusion that managers areproperly incentivized. Somehow these managers have been given free options by innocent savers and investors. I amconcerned here with managers of businesses that are not owner-operated. Nassim Nicholas Taleb, Antifragile: ThingsThat Gain From Disorder

Many of the mistakes weve made that have contributed to mediocre performance over the last couple of years have come asa result of not having been invested with management teams that: 1) Treat minority shareholders the way the managementteams would like to be treated if their roles were reversed; or that 2) Have a track record demonstrating that they have thecapacity to sufferto use the words of Gardner Russo & Gardners Tom Russoby forgoing short-term profits in orderto do what is right to increase long-term intrinsic value. We believe that a primary reason these management teams lackedthese qualities was because they werent owner-operators. They either didnt own a lot of stock in the company; or the sharesthey did own werent significant enough when compared to their other compensation to truly align their interests with us as

shareholders.

In recent years this factor was probably most noticeable with the big banks, though we didnt invest in any of them. Riskyactivities leading up to the financial crisis led to short-term reported profits, which led to large compensation and bonuspackages for the management teams that were much more important to them than their stock ownership in thosecompanies. The end result was short-term gains in reported earnings and extreme risk taking that eventually led to thedestruction or near destruction of those companies, requiring significant government intervention in order to keep the entirefinancial system afloat.

In contrast, Brown Brothers Harriman (BBH), a privately-held partnership that competes with the big banks on many levels,sailed through the 2008 crisis. Though they dont disclose their profits, a 2011 article in The Economistdid mention that 2008was BBHs best year ever. Maybe the skin in the game that comes with the partnership structure had something to do withit?

InAntifragile, Taleb places fragility into three categories: the fragile, the robust (or resilient), and the antifragile. The fragile isharmed by shocks and randomness, the robust stays the same, and the antifragile gets better. Taleb places owner-operatedbusinesses in the robust category, with a special mention of smaller companies when he writes, There seems to be a survivaladvantage to small or medium-sized owner-operated or family-owned companies.

In the past, we have always given great consideration to the management teams of the companies in which we look to invest.We study their track records, look at their incentives, and try to get a thorough understanding of how they view capitalallocation. But it is also just one factor, albeit an important one, among many others. Almost any stock or other asset is agood purchase if the price is low enough. The job for us as portfolio managers is to manage the balance between the qualityand prospects of the business and management team, and the price at which Mr. Market is offering us a chance to purchaseshares.

A mistake we think weve made in some of our previous investments is not giving enough weight to the question ofmanagement team quality when considering how big a margin of safety we require in an investment before purchasingshares. A company trading for six times earnings might not be nearly as good of a deal as one trading at ten or twelve timesearnings, for example, if the latter is run by owner-operators who consistently do the right things to increase the value of thebusiness over a long period of time and treat minority shareholders and themselves as equivalent owners of the business.

Cash combined with courage in a time of crisis is priceless. -Warren Buffett, Chairman, Berkshire Hathaway

Investing with owner-operators that understand capital allocation also has the potential to be a cure, or at least a form ofrelief, for what Fairholme Capital Managements Bruce Berkowitz refers to as premature accumulation. It is hard, if notimpossible, to time the bottom of a stock price when purchasing shares. And it is hard, if not impossible, to predict how

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important macroeconomic riskswhich we are worried about todaywill play out in the future and exactly how they willaffect the businesses in which we invest. But by finding and investing with management teams that are on our side and areconservative with their balance sheets, we can even gain a little bit of antifragility with our investments when volatility erupts,

as long as we are taking a long-term investment horizon so that we may reap the rewards when the smoke has time to clear.

We can gain this antifragility by partnering with management teams that increase the intrinsic value per share of thebusinesses they run when things get volatile, disrupted, or especially when chaos and crisis ensue. They can do this in twoprimary ways: 1) Gaining market share at the expense of weaker competitors and/or buying those weaker competitors atbargain prices; and 2) Repurchasing their own shares at bargain prices. The value added on a per-share basis by performingactions such as these can be enormous. The keys are to find management teams that understand this; are conservative andpatient when deciding what to buy and when to act; and maintain a balance sheet that allows them the flexibility to act, andthe courage to jump on an opportunity when it presents itself.

If you are involved in the management of a public company and you can buy back your stock in the open market for half ofwhat it is worth, conservatively calculated, then you are in essence earning 100% on the capital you use for those buybacks.While the wisdom of repurchases such as this may seem obvious, we again turn to Warren Buffett for further elaboration

and to drive home the point, especially for any of the management teams in our portfolio that may read this letter. As Mr.Buffett wrote in his 1984 letter to shareholders:

The companies in which we have our largest investments have all engaged in significant stock repurchases at times when widediscrepancies existed between price and value. As shareholders, we find this encouraging and rewarding for two importantreasonsone that is obvious, and one that is subtle and not always understood. The obvious point involves basic arithmetic:major repurchases at prices well below per-share intrinsic business value immediately increase, in a highly significant way, thatvalue. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporateacquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 ofvalue for each $1 expended.

The other benefit of repurchases is less subject to precise measurement but can be fully as important over time. By makingrepurchases when a companys market value is well below its business value, management clearly demonstrates that it is given

to actions that enhance the wealth of shareholders, rather than to actions that expand managements domain but that donothing for (or even harm) shareholders. Seeing this, shareholders and potential shareholders increase their estimates of futurereturns from the business. This upward revision, in turn, produces market prices more in line with intrinsic business value.These prices are entirely rational. Investors should pay more for a business that is lodged in the hands of a manager withdemonstrated pro-shareholder leanings than for one in the hands of a self-interested manager marching to a different drummer.

...The key word is demonstrated. A manager who consistently turns his back on repurchases, when these clearly are in theinterests of owners, reveals more than he knows of his motivations. No matter how often or how eloquently he mouths some

public relations-inspired phrase such as maximizing shareholder wealth (this seasons favorite), the market correctlydiscounts assets lodged with him. His heart is not listening to his mouthand, after a while, neither will the market.

Miscellaneous

As a reminder, starting January 1st, 2012, the fund became responsible for accounting, audit and tax preparation costs up to0.50% of net assets per year, on a quarterly basis. Chanticleer Advisors, as previously noted, continues to subsidize theportion of the costs above 0.50% resulting in an acceptable expense ratio paid by fund investors.

We are pleased that Michael J. Liccar & Co. will continue to provide our third-party administration services in 2013, andprepare our tax documents. Our 2012 audit will again be conducted by Joseph Decosimo and Company, PLLC. We expectto have K-1s out toward the end of March and hope to have our annual report ready in early April following the completionof our audit.