Q&A: Silverstone Capital In The Driver's Seat

Apr 29 2010 | 11:14am ET

London-based Silverstone Capital was founded in 2004 and focuses on investments in the automotive industry, notably through the Silverstone Fund and the Monza Fund. The first, according to Silverstone Partner Saul Rubin, is more mainstream, the second a more concentrated and volatile fund intended for a smaller group of investors. The company has recently engaged the Geneva-based MCAM Group to market its hedge fund products.

Rubin took time recently to speak with FINalternatives’ Mary Campbell about a range of automotive industry-related subjects, including China’s rise as a car market, the financial crisis as a missed opportunity for industry consolidation, and why he’s not buying the hype over battery-powered cars.

The news in the automotive industry has been surprisingly upbeat this week – first GM paying back its TARP loans early, then the success of the Beijing Auto Show and China’s rising car sales. How do you see the outlook for this sector?

Well, actually, my answer to this question has been almost unchanging for many years. You’re right, in terms of news, we seem to be going through a good patch, if you like, but the industry is particularly volatile, particularly cyclical, so it can move from very positive to very negative in a fairly short space of time. The most important thing to know is that the industry has been and continues to be beset by overcapacity and too many players. It’s a tremendously competitive industry, it ought to be consolidated on a global level much more than it is, but for many reasons, political and industrial, the industry never has been through a proper wave of consolidation and the hyper-competition means that over longer periods of time the industry tends not to be a good one to invest in—at least if you’re a long-only fund.

But we’re not a long-only fund, we’re a long/short fund and we’re a very sort of traditional long/short fund…we aim to be market neutral and therefore we’re not too concerned about whether the industry as a whole is investable or not from a long-term perspective, we’re more interested in the dispersion of returns within the industry, and they’re very great, which isn’t so surprising because the industry tends to go through big cycles. And because it’s very competitive you get large differences in performance between those that do very well and those that do very badly. So, good dispersion of stock returns makes it very attractive from an equity long/short perspective over longer periods of time. But my answer would have been the same even on day one, which was about six years ago, when we started the fund. And it hasn’t really changed.  The financial crisis should have led to significant consolidation but again…

That’s actually my next question.

Yes, well, at one point there was a great hope that it was going to lead to that, but politics yet again interfered and governments acted, irresponsibly I would say, to save companies that really ought not to have been saved. Particularly irresponsibly, I think, in Europe, where not only were companies saved but they were saved from going through even a modest amount of restructuring that could have led to better returns longer term. So I think that the financial crisis has been a missed opportunity in terms of the industry.

What makes for an efficient, successful company in this industry?

I think it has to do with the area of the value chain that you’re in, actually. I think the business for most manufacturers is pretty tough, [it] always has been and will probably continue to be very tough because they are political beasts, if you like, and there are too many of them.

Much more interesting—again, I’m talking from a long-only perspective—is if you’re looking at what companies can generate good returns over time, or returns in excess of their cost of capital, you really have to look more into the supply base or the after-market part of the value chain. So, in the supply base you get a huge mix, you get some really terrible companies that supply very basic commodity type products—you get quite a lot of them really—and for those companies, life is quite hard. But if you manage to get in a part of the value chain where you’re producing a product that meets the needs of manufacturers from a regulatory stand point (increasing safety or increasing environmental benefits, or just a generally good technology that leads to better vehicles) then you can be very successful because the competitive environment is very different indeed. And then at the other end, in the aftermarket—the aftermarket is a much more stable business—if you’re into distributing car parts or repair shops, then these businesses are, over time, generally much better businesses.

And you see all these companies, at all points on the supply chain, as potential investments?

Oh yes, we invest around the world and in all parts of the value chain—so, from the manufacturing of parts through to the distribution of parts for repair, or even repair shops or car dealers, things like that. We’re involved throughout the value chain—cars, trucks, motorcycles. It’s about 300 companies on a worldwide basis and it’s over $1 trillion in market cap.

You spoke earlier of the advantages of a ‘good technology.’ Right now, that could potentially refer to a green technology. What effect will the effort to make cars more environmentally friendly have on the industry?

Well, for the manufacturers, it’s just another problem, actually. Because it’s just another set of costs that have to be organized and taken care of and in some cases it can be very expensive. And it’s very unclear as to which technology, if any at all, is going to be the one to take off, in terms of battery-related technology, etc. And what that means is that you have to spend quite widely, in many different areas, just in case. And so, for the manufacturers, it’s rather an expensive exercise.

As for the suppliers, it could be a fairly good opportunity because, again, if you find yourself in the right area, it could be a new business and it could be quite profitable. For some, however, it’s going to be very good and then very bad. If you take battery producers, for example, there are tremendous government subsidies for producers of batteries and things, which is potentially going to lead to an explosion of capacity, and if the demand doesn’t come through as anticipated, then it could be very problematic in the longer term.

Do you have any guesses yourself as to which technologies will catch on, or do you just sit back and wait to see how it develops?

Well, a bit of both, really. Because things change, obviously, and conditions change. But at the end of the day, what is certain in my mind is that you can’t build a significant green industry—probably in any industry, but certainly in the automotive industry—on subsidies.  So, you really don’t want to be invested in battery vehicles if the only thing that makes them competitive is the fact that the government gives away money to every consumer [buying a] battery-powered vehicle, because at some point that becomes completely unsustainable, especially with governments running such massive deficits. It’s just not practical for governments to give away money to get people into green cars, that doesn’t work at all.

At some point, battery-powered cars have to become competitive on a commercial basis and this becomes a function of oil prices and, of course, the true seriousness with which governments go about reducing carbon dioxide and things like that, and whether they ought to be even, given the debates on climate change, etc. If you put it all together, I’m actually a great skeptic, I think battery-powered vehicles are a very long way off and are not going to be commercially viable in the near future at all … you may get a small burst because of government subsidies, but I don’t expect much more than that unless you were to see an even greater increase in the price of oil. But I think it would have to be very substantial to make battery-powered vehicles a proper, economic choice for the consumer.

Then there’s also the question of the infrastructure necessary to support battery-powered vehicles, which would also represent a significant investment.

I think the infrastructure issues can be overcome if these things are commercially viable. You’re already beginning to see the construction—on a small scale, particularly in city centers—of the infrastructure for electric vehicles. You’re seeing an increasing number of charging points, for example, throughout London and in other cities throughout the world. And I think that can be scaled up quite dramatically if lots of people bought electric vehicles, but the only way they’re going to buy electric vehicles is if electric vehicles are competitive. And at the moment they are not. There are huge challenges still to be met. So I think at this point there’s a lot of enthusiasm, a lot of hubris, and it may not be quite as rosy as people think.

I will say though, there are lots of other ways to improve fuel economy and consumers will continue to pay a certain amount for improved fuel economy, there’s no doubt about that, and there are lots of other very nice technologies for making continuous improvements in the fuel economy of normal, traditional vehicles, now those technologies will continue to advance, and there may be limited use of batteries, but in terms of full, battery-powered vehicles? No, I’m not a buyer [laughs].

I also wanted to ask you about the rise of countries like China and India as car markets and the effect this will have on the overall industry.

Well, China, definitely. I mean it’s not even emerging as a market anymore—it’s surpassed the United States as a market. China is a fascinating market—I spent a fair amount of time in China recently. India is a long way behind in the development of a car market, and more importantly, in the development of the infrastructure necessary to support a car market. So, India is not of too much interest right now. It could change, maybe, but China is hugely important for the car industry today.

[For] car companies, even two or three years ago, it wasn’t essential to be in China, now it is absolutely essential. It is the biggest market, it’s likely to remain so—China is one country, but it’s like 10 countries in one. It’s an enormous market, I’m sure it’s going to be hugely volatile, but the general trend should be very positive over the next several years. Still, it doesn’t mean that manufacturers are going to make a great deal of money out of the market—it is hugely competitive, probably one of the most competitive car markets in the world today. Unless you have something that really stands out, the market itself isn’t going to save you, you’re going to need something that sets you apart. But if you have that it’s going to a fantastic market.

In terms of China as a producer, is there a stigma attached to the idea of “made-in-China” vehicles? Can you see them being able to export?

You know, at this point, I don’t think it even matters. If I’m a Chinese company, I’m just much more interested in selling to China than I am in selling outside China. That’s my market. China as exporter, I don’t think it’s even a very important story today. A few years ago, it was all about the Chinese coming to Europe, the Chinese coming to America, etc, but it’s a very difficult thing to do for those companies, I wouldn’t say it’s impossible but I think it’s very difficult. I think the Chinese companies who are going to be successful in the next 10 years are going to be the ones who build themselves up by being successful in China—the reality is that if you’re a successful [car] company in China, and then if you want to be in Europe or America, you can probably buy your way in. … Breaking into a new car market is very difficult, very few have done it successfully. I think the likelihood is that there will be some very big native-to-China companies around five or 10 years from now but they will probably be working their way into Europe or North America through acquisitions.

You mentioned that you were in China recently, which leads to my last question about your own investment strategy—how do you go about making your choices?

We run a very valuation-based portfolio. It’s quite a high concentration portfolio. We’re not big traders at all, we tend to take positions and hold them for a reasonable amount of time and we try to get to know the companies we’re investing in as well as possible, so that means visiting them or talking to them over the phone…We base our strategy on very intensive research rather than on high frequency trading, etc.

We don’t go into the size of the funds unless people sort of come to us and talk to us, but in terms of the difference in strategy [among the two funds], it’s very simple actually—Monza is basically an even higher-volatility portfolio than Silverstone. Silverstone is more mainstream, quite high concentration, quite a focused fund. Monza was really set up to meet the needs of a small number of investors willing to accept quite high volatility and large positions in the portfolio.


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