Claudio Guazzoni – Eliminating the Downside

This article is part of our 'Guru' series - profiles of successful traders, with takeaways for the UK private investor.
You can find the rest of the series here.

Today’s post is a profile of Guru investor Claudio Guazzoni, who appears in Jack Schwager’s book Stock Market Wizards. His chapter is called Eliminating the Downside.

Claudio Guazzoni

Claudio Guazzoni runs what is usually described as a hedge fund, but which sound more like a private equity operation to me.

Claudio appears in Jack Schwager’s book Stock Market Wizards.

• His chapter is called Eliminating the Downside.

Early days

Claudio Guazzoni’s family moved to the US from Italy when he was a teenager.

• His parents were nuclear physicists recruited by the Department of Defense.

Claudio studied comparative literature and economics at college then became a photographer.

I decided if my reason for working was to make money, I might as well go into business.

I had a friend who worked at an investment bank. He said, “You speak five languages; they need people like you.” I interviewed with a number of banks and chose to accept a very lucrative offer from Salomon Brothers.

He started out in the bond department in 1985, which means that he worked alongside Michael Lewis at the time of the book Liar’s Poker.

It’s a very entertaining book. It accurately describes Salomon Brothers at the time, but I believe it inaccurately describes Michael’s particular role at Salomon Brothers.

After three years on the government bond desk in London, Claudio transferred to Salomon’s M&A department in New York.

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After that he moved to a leveraged buy-out (LBO) firm.

The basic idea was that a loan could be obtained against the company’s cash flow. You could go to the shareholders and try to buy the company with a loan from the bank and a very thin slice of equity from investors.

After ten or fifteen years, you would own the complete company by having used the company’s own money.

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Frustrated at not being able to get his ideas implemented, Claudio set up on his own.

I started looking for other investment opportunities that in my opinion had very limited risk.

At the time, there were many CEOs who owned a fortune in their own company stock, but who could not sell any part of their holdings on the open market due to restrictions. I thought I could buy it privately for 50 cents on the dollar.

I took on the restriction. I couldn’t sell the stock until the restriction period was over.

At the time, lock-ups were usually for three years, rather than the six month that is common today.

Performance

Schwager says:

Guazzoni’s fund has yet to register a losing month. Returns have averaged 37% pa over more than five years.

Trading style

We are not rocket scientists. We simply judge people’s characters and their abilities to get themselves out of trouble. The CEOs and other top management.

We judge a person’s character. As one example, we look for people who don’t cheat on their wives. If someone will cheat on his wife, then he will cheat on me too.

Eighty percent of the business we do is acquisition finance. Small pockets of industries still exist that are very fragmented with lots of so-called mom-and-pops. Consolidators have developed to purchase and roll up these mom-and-pops.

We currently have thirteen companies in our portfolio, and each of them is a consolidator.

So Claudio funds rollups, a favour of company growth that is frowned on by most of the UK private investors that I come across.

It sounds like a form of private equity:

The companies we invest in are already listed on a stock exchange, whereas venture capitalists typically come in at a much earlier stage. We finance their expansion, and in return they give us privately placed equity.

We try to eliminate the downside. If you eliminate the downside, you end up  making money at the end of the year.

As long as the company stays in business, we are assured a minimum preferred return on equity of between 10 and 20 percent. If the company does well, our upside is heavily skewed.

[From ten dollars to] seven dollars, $5, or $3, our returns are still the same. If, however, the stock goes from $10 to $15, we share in a large portion of the  upside. And from $ 15 to $20, we might share in an even larger portion of the upside.

The deals usually involve Claudios’s firm receiving some kind of preferred equity.

Competitors

We compete with banks all the time, but there are many reasons why companies come to us.

Banks are very bureaucratic and take two or three months to approve loans. If necessary, we can work twenty-four hours a day, seven days a week to make a deal happen quickly.

We not only provide money in a timely manner, but we also offer strategic help  in a company. In a sense, we become partners with the companies we invest in.

Conclusions

This is a nice enough interview, but as Schwager says:

Claudio Guazzoni’s approach, which requires tens of millions of dollars to implement, is hardly accessible to the average investor.

[But] he started out with a simple idea – buying restricted stock at a discounted price – and built his enterprise one deal at a time, with his initial stake raised from others.

Complexity is not a necessary ingredient for success.

Guazzoni says:

Every period of time has its own opportunities where you can find investments that are extremely discounted and have a very well protected downside.”

I’m not entirely convinced by that as I write this article – opportunities seem thin on the ground at the moment, and most valuations are full.

• Until next time.