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when people ask me what I read"

— Norbert Lou

Southwestern Energy: Value Investing in Real Life

One of my ongoing interests is how great value investors can be found allocating capital within companies, not just in companies’ securities.  In other words, you don’t have to be a money manager per se to be a value investor and many of the best value investors work in “real” companies.  If you are in the business of scouting for and identifying great value investors, you widen your universe greatly by looking at these real companies in addition to hedge funds, mutual funds, etc.

One case in point: Southwestern Energy and its leader Howard Korell, recently profiled in the FT.  Once upon a time, oil and gas exploration companies were nearly equivalent to what hedge funds are today:  a man got together a group of investors in a limited partnership, the LPs were charged an incentive fee, and the man took the investors’ money and invested it in a portfolio of oil wells he thought would yield profits.  Substitute the word “securities” for “oil wells” and you have a hedge fund.

Today most oil and gas exploration is housed in corporate form, and the incentive fee compensation comes in the form of stock options and bonuses, but the idea is the same: passive equity partners (shareholders) entrust their capital to managers who use it to invest in a portfolio of exploration projects.  And wherever you have investing, you can find value investing.

The FT article indicates that Southwestern under Korell excelled at two of the basic tenets value investors hold dear:

  1. The Charlie Munger idea of virtuous (from the Latin word for “manly,” a word Munger may be the last on earth to say without irony) investing being about waiting and waiting, no matter what criticism you have to endure, for a situation in which the odds greatly favor you, and then betting big once you find one, again no matter what criticism you have to endure.  That’s how Munger ran his partnership, and while this approach produced great volatility and some grief, he endured it stoically.  Southwestern made a huge and lonely bet over two long years, buying up drilling rights in the Fayetteville shale.
  2. Buy things cheap.  Oil and gas leases don’t trade publicly, but they do trade frequently and with pretty good liquidity.  Like stocks, they represent claims on future cash flows which are uncertain.  And like stocks, they can be overpriced or underpriced.  A good lease at a too-high price is a bad investment, no matter how much oil or gas everyone knows it produces.  Southwestern Energy under Korell pursued only those leases that promised the best returns for the price paid.

The result was an annual return for Southwestern shareholders of 4,374% in the past decade.  If that were a hedge fund, it would be the subject of many a Manhattan cocktail party.  But since it’s an oil and gas outfit in Houston, most people in finance have probably never heard of it.  Fortunately for Southwestern’s long-term shareholders, the money spends exactly the same no matter what you call it.