Morningstar Advisor - Summer 2008 - 56

Morningstar Conversation Google is doing the right thing on their capital spend because they’re raising their barrier to entry. Speaking of free cash-flow and dynamic growth, I’d like to bring up the commodities and materials—Rio Tinto and BHP, for example. It’s all coming from pricing power, but these are dynamic growth companies. They’re both cyclicals in a sense. Huge free cash-flow machines. They want to do acquisitions—mostly for cash, to lever back up—because they realize that they can buy reserves in the public markets cheaper than they can explore for them right now—the reserves you can explore for are not as good as the reserves that others already have. Pernod Ricard just bought Vin & Sprit, which makes Absolut vodka. I bought Pernod after that acquisition and have bought more since. I really like this deal. It was predominantly financial engineering. They can borrow money at 6%. They get a tax benefit in the U.S. for the whole thing because of the M&A laws about writing off brands. Instantly, cashwise, very accretive; most people missed the tax thing. Then as it grows modestly and they de-lever— massively accretive to growth rate. People say, “Well, but they overpaid.” They paid a full price, but you missed the fact that because of the U.S. tax man it was a fabulous acquisition. In every industry, you have to say, “Do they have the chance to deploy excess capital at good returns?” You never presume that, but then you look at the disciplines. In a Pernod’s case, I liked what they did. In other cases, it’s not as clear to me. It’s all different. Kunal Kapoor is president and chief investment officer of Morningstar Investment Services (www. mp.morningstar.com). T. Rowe Price Global Stock is a holding in Morningstar Investment Services’ portfolios. Kapoor personally owns shares of the fund. The more people say, ‘Well, this is really odd,’ the more I think, ‘Hmm, maybe I should buy more.’ That sounds like I’m a value investor. Robert Gensler RG: It’s totally in line with everything! If you think about a strategy like this, I want to win in all environments. I want to win in up markets, down markets, sideways markets. I want to win in recession, in hyper-growth. I don’t care. There’s no get-out-of-jail-free card because you say this is the wrong environment for this style. I also think that with where we are in the economic cycle the economies are slowing and inflation’s picking up. I want to have a strategy that has some dynamic growers, like a Google GOOG, like a Bharti. I also want to own the moderate growers, such as Toyota. But I also want to own these companies that are a bit—well, some people have tagged me as doing contrarian growth. Last year, we bought 4% of the strategy in homebuilders. With the rally this year, if we hadn’t sold any, it would be at 6%. We’re under 2% now, because, you know, valuation always matters and all. Alcatel-Lucent and Sprint in some ways are no different. We’ve actually made some good money on both those stocks. The more people say, “Well, this is really odd,” the more I think, “Hmm, maybe I should buy more.” That sounds like I’m a value investor. KK: Many of the faster-growing firms that you own generate a lot of excess cash. How do you judge how well that cash is being deployed? RG: Each situation is different. Take Google, for example. One of the best things they did was buy YouTube. Wow! They are completely right that the Internet will go from 2-D to 3-D. People are watching YouTube almost as much as they are CBS, ABC, or NBC. It’s the new TV. And there is zero value in Google for YouTube, and I don’t know how they’ll monetize it, but they’re making the right bets in their acquisitions. Much smarter than the silliness of eBay EBAY when they bought Skype. See more of Gensler and Kapoor’s conversation on video at MorningstarAdvisor.com. 56 Morningstar Advisor Summer 2008

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Morningstar Advisor - Summer 2008

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