Spare a thought for Allan Mecham. At first glance, it's hard to feel sorry for the head of Arlington Value Management who, at 34 years old, logged a 400% return over the 12 years to 2011. He did it without an MBA or even a college degree. No Manhattan office either (try Salt Lake City), or whizzy Excel modeling or Italian suits. Just "a handful of common-sense tactics," as financial columnist Brett Arends wrote in 2012.
Sound familiar? The combination of middle-American humility and remarkable investing acumen inspired Arends to reference a certain Omaha investor more than once in his profile of Mecham. A couple of years later—as Arlington continued to rack up mouth-watering gains—Arends (or an editor) took the plunge and wrote the headline: "Is This The Next Warren Buffett?"
Being tapped as a Baby Buffett may be the most dangerous compliment an investor can receive. Laden with expectation and no small quantity of sinister magic, the label has proved disastrous for more than one investor.
Take Eddie Lampert. He was hardly out of Yale, where he was roommates with future Treasury Secretary Steven Mnuchin, when he landed an internship and then a job at Goldman Sachs. By age 25 he'd started his own hedge fund and begun began notching up 29% average annual returns. His clients included David Geffen and Michael Dell. His secret? "Some of the least sexy investments around," as a 2004 Businessweek profile put it.
The comparison was inevitable: "The Next Warren Buffett?" ran Businessweek's headline. Lampert had scooped up a majority stake in Kmart following its 2002 bankruptcy, spending less than $1 billion on a company that—once it announced a merger with Sears—sported an $8.6 billion market cap and a "Buffett-like premium."
Sears Holdings Corp. (SHLD), as the merged entity is known, was flying high for years, but when the downturn came in 2007, it fell and couldn't get up. The company that was set to be "the next Berkshire Hathaway" (BRK-A, BRK-B) has now become a hollow shell. Its corporate edifice resembles its stores: as shelves empty out, perhaps never to be replenished, the company is shedding brands and real estate in a string of increasingly desperate spin-offs. Sears' is the kind of stock that rises on announcements of mass store closures, since such measures stave off the specter of bankruptcy.
With the "Next Buffett" albatross hanging around his neck, Lampert embarked on an Ayn Rand-inspired overhaul of Sears' structure. In 2008 he chopped the company up into 30 divisions and made them operate as separate businesses. Each would hire its own executives, swelling payroll costs. When units needed to cooperate, they negotiated contracts among themselves; at one point the appliances unit, put off by the Kenmore unit's prices, favored South Korean conglomerate LG's products instead. Amazon.com Inc.'s (AMZN) predations hardly helped. Sears lost $2.2 billion in 2016, the sixth year of a $10.4 billion losing streak.
J. Michael Pearson
At the 2015 Sohn Conference, an annual gathering of hedge fund types in New York, Pershing Square Capital Management chief Bill Ackman claimed to have spotted an early-stage Berkshire Hathaway: Canadian drugmaker Valeant Pharmaceuticals International Inc. (VRX). Like Berkshire, Ackman argued, Valeant is a "platform," a business "managed by superior operators that execute value-enhancing acquisitions and shareholder-focused capital allocation."
He was right that Valeant, like Berkshire, was acquisitive: it merged with Biovail in 2010, snapped up Medicis in 2012, then bought Bausch & Lomb in 2013 and Salix in 2015. In his Sohn presentation, Ackman stressed just how lucrative this strategy had been, plotting Valeant's acquisitions on a graph that showed the relentless rise in its stock price. An investment made the day Pearson became CEO (February 1, 2008), Ackman calculated, would have returned 4,502% as of May 1, 2015.
A little over two years later, all of those gains have been erased. "Someone's sitting in the shade today because someone planted a tree a long time ago," Buffett has said. Even if the Oracle of Omaha doesn't exactly plant the metaphorical tree—you might say he buys it and tends to it—Pearson's strategy was more akin to ripping the tree out of the ground, shoving it through a woodchipper, and flogging the result as overpriced brand-name potpourri.
Whenever Valeant acquired a drug, it hiked the price, sometimes abruptly and steeply: Isuprel, a drug that is used to maintain patients' circulation during surgery and has little in the way of safe substitutes, shot up 525% in 2015. When Martin Shkreli's Turing Pharmaceuticals raised the price of a 60-year-old AIDS medication from $13.50 per pill to $750, lawmakers subpoenaed Pearson as well as Shkreli. Testifying before the Senate in April 2016, Valeant's CEO could not name a drug his company had acquired without subsequently raising the price.
Meanwhile, an accounting scandal was hastening Valeant's decline. Riffing on The Graduate's "plastics" scene, Australian short-seller John Hempton wrote on Oct. 15, 2015, that he had "just one word" for readers: Philidor. He did not mention Valeant, but markets realized quickly enough that Philidor was the specialty pharmacy through which the drugmaker funneled high-priced branded drugs to patients who could have used generics instead. Valeant also booked $58 million in revenue from Philidor early, forcing it to restate several quarters of results.
Valeant may have looked Berkshire-like in the two years to August 5, 2015, when its shares shot up 175% to a record close of $262.52. The label looked less apt the following April, when Pearson was pushed out by Bill Ackman, the same investor who had compared his strategy to Buffett's. On the day of Pearson's ouster, Valeant's stock closed at $35.16. At the time of writing, it trades below $13, a depth it last plumbed in 2009.
Having burdened Pearson with the Next Buffett label, it is only fair that Ackman should feel its weight himself. "Baby Buffett," Forbes' May 25, 2015 cover proclaimed: "Wall Street's loudmouth banked over $1 billion last year. Now he's quietly creating the next Berkshire Hathaway." Arms crossed, Ackman coolly surveyed his domain. The subhead ended in a mischievous parenthetical: "(Want in?)"
No thanks, the market replied. Pershing Square Holdings Ltd. (PSH.NA), the Amsterdam-listed public segment of Ackman's hedge fund Pershing Square Capital, has lost over a third of its value since debuting in October 2014. Ackman's bet against Herbalife Ltd. (HLF), which he has maintained since 2012, has not panned out. In March he sold his $3.2 billion stake in Valeant at a loss of over 90%. Successful bets such as a position in recovering Chipotle Mexican Grill Inc. (CMG) have eased the pain somewhat, but Ackman's Buffettesque claim to "invest in very stable, predictable businesses" has convinced few.
Perhaps there's hope. So far Seth Klarman has managed to escape the ravages of the "Next Buffett" curse despite years of repetition. There are a number of potential explanations. Perhaps he has been spared because, despite several headlines using his name next to the B-word, the only truly eminent publication to run such a profile opted for a euphemism: "The Oracle of Boston" (where Klarman's Baupost Group is based). Another possibility is that Klarman has been inoculated by Buffett's own public praise.
At the risk of jinxing Klarman further, it is also possible that he is the genuine article. Klarman has more than a whiff of Buffett about him. He scoffs at demands to beat other funds or benchmarks, arguing that capital preservation is more important (his fund has lost money in just three of the last 34 years). He eschews leverage and will keep large cash positions when he feels the risks outweigh potential returns. A conservative approach hasn't inhibited performance, though. Morgan Creek Capital Management calculates that Baupost generated a 16.4% compound annual return in the 33 years to 2015 (lagging Buffett's 20.8%).
Like Buffett, Klarman also writes, and he writes like Buffett. "Buy bargains," he counseled in a 2015 Financial Times column. "Quality matters, in business and people... Consistency and patience are crucial... Liberate yourself from short-term performance pressures." If it weren't for a lack of folksy metaphors, the column could have been written by Buffett himself. In a measure of the demand for Klarman's wisdom, an out-of-print book he wrote in 1991 sells for $720 (used) on Amazon.
With luck, Allan Meacham, like Seth Klarman, will shake off the bad "Next Buffett" vibes and continue to rack up impressive gains. In his 2016 letter to investors, he wrote that his AVM Ranger fund gained 29.1% that year, for a compound annual gain of 30.7% over the previous eight and a half years. Suspiciously selective time period aside, that is impressive. Mecham remains realistic, however, answering his own question about whether Arlington will be able to maintain such a track record over the long run: "we won't."