Fund Managers’ Favourites: Turnaround Time

So, Alex, thanks for coming in.

Alex Savvides: Thanks for inviting me.

Petroff: Now, let's talk specifically about why you have achieved this outperformance. What is it about your strategy for investing that you think has helped you outperform?

Savvides: So, we launched the fund in June 2008 into very tough and volatile stock market conditions. And the process that we run tries to benefit from companies that are going through short to medium-term issues. We try to invest in companies at low points in their life cycle, and that typically leads to investing in companies that are going through either restructuring or recoveries, or companies that are hidden growth companies in the stock market. And I think that's proven to be a very successful way of investing over the last four to four and a half years.

Petroff: Okay. The contrarian kind of strategy.

Savvides: I think so. There has been lots of opportunities in the market to pick good companies at low prices because of the inherent fears that have been around in investors' mindsets.

Petroff: Okay. So, there is a bit of fear around that three picks that you've chosen today: we have BP, 3i and Xchanging. So, in particular, let's start with BP; still definitely some fear around there.

Savvides: Absolutely. The attractions to us in BP shares are threefold. Firstly, we think, like you say, there is still a substantial amount of fear over the ultimate liabilities that BP faces for the Macondo incident. BP has actually set aside about $41 billion to pay for liabilities around the oil leak. And in our view the share price is discounting an outcome much worse than this, possibly for another $30 billion plus of liabilities, but we think that is way too pessimistic and that the actual outcome will be around $6 billion more. And the value differential between the $6 billion and the $30 billion plus is about £1 on BP share price; very attractive to us in terms of margin of safety.

Petroff: Okay. Moving on to 3i, why do you like 3i right now? What is it about 3i that's getting you excited?

Savvides: Okay. Well, 3i is a mid-cap company in the private equity and debt management space. True, it has had a very tough five years on the stock market. I think previous management team have reacted slowly to the prevailing stock market conditions for raising private equity funds and for realising private equity assets. But we think under the new management team of Simon Borrows, who comes with a very good track record at other financial companies, the business is going through a very good and cash-focused restructuring and refocusing. And we think the business is being improved along multiple lines, and that those improvements are yet to find their way into the share price. The shares trade at a 30% discount to their core NAV, but we now have a very pragmatic management team doing the right things and we think that discount will unwind in the future.

Petroff: Okay. Now, moving on to the smallest company out of your top three, we have Xchanging. Why do you like Xchanging?

Savvides: Xchanging again is a company that's had a checkered history on the stock market. It has a history of acquiring badly certain companies in the outsourcing space. Xchanging itself is a business process outsourcing company and procurement company. It also has a legacy of signing some contracts that have ended up being cash consumptive to the group. That led to a big decline in the company's share price.

Again, the attraction we saw was a strategic shift from a new management team. Ken Lever joined the board in February 2011 as CEO, and he has restructured the business fantastically well over the timeframe since then. He has sold under-performing cash consumptive businesses. He has got out of any contracts that were draining cash from the business or restructured those contracts, and he has been critically investing for growth in the business. And we think that growth will come through now to drive revenue growth ahead of analyst expectations in the stock market over the next few years.

Petroff: Okay. Now, let's talk about the three key risks for each of these companies. I think generally there are some risks that are pretty evident, but what do you think the key risks are for each of these three companies?

Savvides: So, in the case of BP, clearly the risk is around the ultimate liability that we get over the Macondo incident. We may not get visibility over that for the next year or so. There is actually a court case scheduled to start in February next year. So, I think it's a timing risk around completion of the ultimate liabilities.

In the case of 3i, I think it's very much a market risk around the company's ability to raise new private equity funds. And their ability to do so will be driven by the new private equity go-to-market strategy that they have. And again, that will take time to come through and manifest itself in raising new funds.

In the case of Xchanging, I think the risks are mostly around existing contracts that the company has, whether they can resign those contracts when they come up for renewal over the next couple of years, but I think with this management team and with recent experience of contract renewals where they've been very successful, we are quite confident.

Petroff: Okay. Thank you very much for coming in today.

Savvides: Thank you.

Petroff: That was Alex Savvides from JO Hambro Capital Management. I am Alanna Petroff. Thank you very much for watching Morningstar.