The TSC Streetside Chat, Part 1: Marc Perkins of Gunther International

Marc Perkins was a longtime member of the Barrons Roundtable and of the fraternity of smart guys on Wall Street. He was also one of the funnier and more candid guys around the Street. He quit the business in 1998 after about 30 years. He retired to Connecticut to run Gunther International, a publicly traded company that manufacturers high-speed folding and sorting machines for large companies.

TSC Chief Markets Writer Brett D. Fromson recently traveled to the country to talk with Perkins about the bad old days in lower Manhattan and elsewhere. Perkins talked at length about a host of people and topics including Warren Buffett, Peter Lynch, Alan Abelson, Salomon Brothers, lies traders tell, the superficiality of sell-side research, his greatest regret, his biggest mistake and why he left the business he loved so much.

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Brett D. Fromson: Marc, what have you learned from ... what ... 30 years as a money manager?

Marc Perkins: Just about. The most important thing I've learned here as CEO of Gunther International (SORT:Nasdaq - news - boards) is that anybody who thinks you can figure out to any reasonable degree what's going on inside a company from the outside is crazy. I mean, it's a useless exercise.

Brett D. Fromson: Fundamental research is pointless?

Marc Perkins: No, not at all. But research is really much more important for what's going on around the industry. The research tells you if a new product is great. That's good research. But digging into a company to figure out whether they're going to earn 18 cents or 17 cents in the next three months is crazy. It's impossible because there are so many variables inside a company, and management has so much flexibility in what they want to report; it has all just become a game. They tell you what they're going to report. You tell everybody else they're going to earn a penny less than that. Then when they come in with what management told you, they outperform by a penny, and the stock goes up. It's just become this game, but if investors think there's anybody actually sitting around doing models that are effective and that work, or figuring out what the earnings of companies are, they're crazy.

We have good research figuring out how many PCs are going to be sold next year -- taking macroeconomic numbers and figuring out whether the PC industry is going to be a good industry for the next few years. It's making big decisions on what the model is going to be for the PC business. It's deciding whether the price of oil is going up, whether the dynamics for supply and demand in the oil industry are appropriate.

Brett D. Fromson: How did you come to this conclusion since joining Gunther?

Marc Perkins: When you get inside a company, you realize how large the dynamic is, and how many things are changing. We're sitting here in a company, it's a little, tiny company that used to be followed by lots of people on Wall Street because Harold Geneen was involved. And the reality is, everybody went around and they studied the company and they did all their homework. The fact of the matter is, the books weren't even close. I mean the books were off by millions of dollars. And they were reading these financial reports, and they didn't know whether they were right or wrong.

Brett D. Fromson: And they'd been audited.

Marc Perkins: And they'd been audited by Arthur Andersen, and they turned out to not even be close. In this particular case, the company refinanced when the truth came out. But my point is that here you've got a company, which, if you really go back and look at the numbers, was bleeding cash when it was supposed to be generating lots of income.

Brett D. Fromson: Was that because of fraud?

Marc Perkins: No, just stupidity. Senior management was, to put it mildly, incompetent, and there were no systems. No Wall Street analyst came in here and looked around and asked questions like, "What type of internal controls do you have?" "What type of integrated management package do you have to make sure your place is under control?" The answer to those questions [would have been] "none." There was no management software package. There was no accounting software package. It was all being done, literally, on legal pads. At the end of the quarter, they sat down with a legal pad, took stuff off of the printout they had of the general ledger, and put together financial statements.

Brett D. Fromson: And the analysts just bought it, because it was audited?

Marc Perkins: And then they bought it because it was Harold Geneen.

Brett D. Fromson: When, this is back in the '90s?

Marc Perkins: All through the '90s. We've only gone and looked back to 1997. Who knows what happened before then, but certainly back in 1997 the numbers were a fiction of somebody's imagination. There's no evidence that anybody did anything wrong or whatever. It was just blatant incompetence. But my point is, these people are sitting there and they're telling the analyst types and the brokers, "Here's what we're doing. Here's how much we make. Here's the business model we're working on." And everybody sits there writing it down, but nobody has the foggiest idea how much of it is true.

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"Anybody who thinks you can figure out to any reasonable degree what's going on inside a company from the outside is crazy."

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Brett D. Fromson: So what then is the kind of fundamental research that can really be done that is valuable for an investor?

Marc Perkins: Well, I'll give you an example of one of the best calls we ever had -- and everybody, of course, always thinks of the good ones. But we were short a stock in 1996, called Acclaim Entertainment (AKLM:OTC SC - news - boards). That was the software company that did Mortal Kombat. And they were coming out with some new games. We were convinced that they weren't selling what they said they were. So we went around to stores and just interviewed the people in the stores that were actually selling the stuff. We posed as buyers of large quantities of games for a charity, and called up every Toys R Us (TOY:NYSE - news - boards) store in a Yellow Pages up and down the Southeast. We told them we were interested in large quantities, asked them if they had them in inventory, and they all said, "Mister, we got plenty of these things. We got 'em coming out our ears."

There was a story going around about a shortage of the product because they were selling so fast. So we were asking, "Oh, you got a couple hundred of them?" The stores said, "No problem, just come right in." And so we got short the stock. And then the company made its numbers. They ran the stock from $20 to $30, and I'm scratching my head saying, "This is impossible, but I guess we're just wrong."

Then, about three weeks later, they came out with what I call the "Emily Litella" press release. Emily was a character on Saturday Night Live played by Gilda Radner, who used to end her skit every week by saying, "Never mind." They announced, "Well, we released the report prematurely because these folks called our auditors [and] had some minor issues." And it turns out that a substantial portion of the revenues were estimated future revenues on contracts that they had just signed, with franchisees or sublicensees in unnamed foreign countries for unnamed periods to sell unknown quantities of this stuff, and they'd booked all the income as current.

The auditors wouldn't let them do it, and the stock collapsed. That's the kind of really digging into the business itself that can be valuable. What's going on with the business? Looking hard, reading footnotes, and getting into accounting and finding the things companies often don't mention. The number of people on Wall Street that actually do that are few and far between.

Brett D. Fromson: How in your experience is serious money most often made?

Marc Perkins: By recognizing changes and significant trends and holding on. Seeing the Internet as a business concept, and what it was going to bring with it. And getting in, and then just hanging on. Realizing, when oil was $35 a barrel, that at $35, you could pump oil out of the woodwork. That at $35, you could convert coal oil and make it work. And it couldn't stay up there.

Herb Stein, who not only was the Chairman of the Council of Economic Advisors and the father of Ben Stein, but a neighbor of mine when I was a kid in Silver Springs, Maryland, used to say, "Things that can't happen, don't." Sounds stupid, sounds whimsical, but it actually is a powerful investing concept.

When you say things that can't happen, don't, that means things like when interest rates are at 20%, they can't stay there -- it'll break the back of the economy, it will destroy the economy. Interest rates had to come down. Peter Lynch is a brilliant and wonderful guy. But I happen to believe that the vast majority of Peter Lynch's legendary performance comes from one great decision. Interest rates coming down. And he bought every financial stock he could lay his hands on when interest rates were 20%, and they were selling at fractions of book value. I don't want to make it sound like I'm demeaning any part of Peter's performance because that one decision was enough, and it was brilliant.

Brett D. Fromson: What's your point?

Marc Perkins: My point is that Peter made one great macro decision. And hung on. And that carried him out for a long time. And he really stuck with it. He understood the decision. He understood that interest rates could not stay at 20% or go higher without killing the entire economy. Things that can't happen, don't.

Brett D. Fromson: What's a reasonable expectation for investors to have for their long-term performance?

Marc Perkins: The fact is, that over time, if you look at returns on stocks, they're essentially 9%. If you take every closing price in the history of the New York Stock Exchange and assume you sold it on every subsequent day, and you average out all of those trillions of returns, you come up with about 10 % now. But for years it was 9%. When we go into a bad market for a while, that number will probably go down to 8%. Then we'll go back up to 9%.

There's a reason why it's 9%. And the reason is that the average corporate dividend yield over history has been 4.5%, and the average growth rate has been 4.5% -- 4.5 and 4.5 equals 9. If you want to earn more than 9% over time, then you have to play for increases in valuation. The dynamic that makes it work is changes in valuation.

Brett D. Fromson: Changes in multiples.

Marc Perkins: Right. That's valuation. And that only comes about because of some fundamental change. Interest rates. A big change in technology. A big increase in the price of fuel.

Brett D. Fromson: Why did you leave the business of managing other people's money?

Marc Perkins: People are just too greedy. That was the real reason I left the business.

Brett D. Fromson: Explain.

Marc Perkins: I was underperforming in 1997-98. Some clients I really wasn't doing very well for. Others, I was underperforming for but doing a great job for them because they were clients who really didn't have much of a risk profile. But everybody thought they were entitled to 30% a year as an entitlement. It was like their Social Security check. If the stocks didn't come in with 30% some year, they felt they'd been gypped. It got to the point where it just became too difficult to communicate with clients.

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"If you want to earn more than 9% over time, then you have to play for increases in valuation."

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Brett D. Fromson: Who were your clients?

Marc Perkins: Wealthy individuals. Mostly self-made. Some were very long-term clients, and the very long-term ones were less of a problem. But there was one in particular that I thought I had done a great job for, who needed money to live -- this was not just somebody who was rich and had a portfolio that was just a scorecard. He was somebody who needed money to live. And I took half of his money and put it in a fixed-income portfolio and never returned less than 800 basis over Treasuries, which by anybody's measure, is a helluva performance in a fixed-income portfolio.

Brett D. Fromson: How did you do it?

Marc Perkins: Got lucky. In 1994, when Orange County broke in the municipal derivatives crisis, there were a lot of fairly high-quality mortgage securities that fell within the general definition of derivatives. And they just collapsed in price.

Brett D. Fromson: They were secured by mortgage payments?

Marc Perkins: Single-family mortgages. They were single-family mortgages with twists. You had some where they were broken into two pieces and you had the interest-only strips or you had the principal-only strip. There were really two parts -- one was a zero coupon government and the other an interest coupon of indeterminate value where the rate depends on the level of interest rates. If interest rates go higher, you earn nothing. If interest rates go down, you earn a lot of money.

During the crisis, there were lots of those that were selling below the value of the zero coupon. So in essence you had government-backed bonds that were zero coupons plus an income stream of indeterminate amount. The bonds were yielding 300-400 basis points above comparable government bonds, and then, if interest rates went down, there was another income stream. Of course, interest rates stayed down, so the income stream turned out to be worth a lot of money, too.

Brett D. Fromson: So this client made good money. Half the portfolio was in that kind of stuff.

Marc Perkins: Right.

Brett D. Fromson: The other half?

Marc Perkins: Was stocks that went up. This particular account, just long. It was scattered all over the place, and went up probably a few points behind the market because there was always a nice cash reserve. Because I always thought he was going to need it. Here was a guy who needed money to live.

He kept going to his club on a Friday night and hearing everybody talk about they were long Intel (INTC:Nasdaq - news - boards) or they were long Microsoft (MSFT:Nasdaq - news - boards) and they were up 40%, they were up 50%, and he said, "I'm gonna go get me some of them 30% stocks."

Brett D. Fromson: And what were you getting for him?

Marc Perkins: 20-plus. And we never had a down trailing four quarters. That's all the way through the bad market of 1994.

Brett D. Fromson: What ultimately happen with this client?

Marc Perkins: He just one day said, "I'm gonna get me some of them 30% stocks."

Brett D. Fromson: He pulled his money?

Marc Perkins: Yeah.

Brett D. Fromson: How much was it?

Marc Perkins: It was in the 7 figures, not 8, but 7.

Brett D. Fromson: OK, so not tens of millions, but millions. And why was that so important to you when it happened?

Marc Perkins: Because the reality was that relative to this guy's risk profile, I'd done a sensational job. This was a guy who I would have been justified telling just to take his money and buy Treasuries, because he really needed money to live. He had no other source of income. And if the principal goes, he's done. And he was a guy with a personal history of nothing but investment losses. He was a guy who had a huge income in his lifetime and had continually speculated with it -- oil stocks when oil was $35 a barrel, real estate shelters in the late '80s. I just got tired of dealing with that. Gunther International became available. I said, "This looks pretty interesting." So we put together some investors, and it's really been fun. The nice thing about this, as opposed to the investment business, is when you're running a company, if you're right, you're right. When you're picking stocks, you can do all the research in the world. You can get the trend right. You can get the company right. You can do all the fundamental research. And you still get killed because you get run over by the mob.

Brett D. Fromson: You still invest outside Gunther?

Marc Perkins: I still play around. I like a stock right now that nobody wants to own. I mean nobody.

Brett D. Fromson: What's it called?

Marc Perkins: Meditrust (MT:NYSE - news - boards).

Brett D. Fromson: What is Meditrust?

Marc Perkins: Meditrust is a is a paired share REIT, a health care REIT that also owns 300 La Quinta hotels and a bunch of retirement homes and assisted living facilities and medical office buildings. Paired share status is where you actually have two different sets of shares within the REIT. You have a REIT, and you have an operating company, and you can put 'em together, and they still have REIT status.

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"Is it chocolate or is it peanut butter? The real trick is to be able to understand when a growth stock becomes a value stock."

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Brett D. Fromson: What's the advantage of a paired share REIT?

Marc Perkins: No taxes to the company. As long as you pay through 90% of your net income, there are taxes only within the distribution to the holder. So they amassed a multibillion-dollar portfolio of health care and hotel properties. And mostly long-term care facilities. So the hotels go to crapper.

Brett D. Fromson: This is when?

Marc Perkins: Now. The midrange hotel, the midpriced hotel business that La Quinta is in gets soft. But I can see rates are down a little bit, but the company is still making lots and lots of money, but the hotel business is soft, so nobody wants to invest in it. And nobody wants to invest in the health care business, the long-term care business because of Medicaid problems, fraud problems, political pressure. So here you have a stock that has gone from the low-to-mid 30s to $3. But here you've got a company in the latest quarter, with a market cap of about $300 million that in the last quarter generated $59 million in cash.

Brett D. Fromson: That's the bottom line?

Marc Perkins: It's FFO. Funds For Operations.

Brett D. Fromson: Why is the stock at $3?

Marc Perkins: Well, because it's in two industries everybody hates. They have asset-quality problems. They have some loans on some properties they own that are leased to companies in trouble.

Brett D. Fromson: The fear is that they might not get the interest income?

Marc Perkins: That's correct. But if you add all of that up, you still end up with La Quinta, which will have over $200 million in EBITDA this year. Probably a lot more than that. It has earned $300 million in EBITDA before. Lakita has $2.6 billion book value. You have $2 billion of health care properties, and $1.6 billion in total debt. They're generating a couple hundred million a year in cash, with a market cap of $300 million. You can't give it away.

Brett D. Fromson: What does that tell you about this stock market?

Marc Perkins: Nobody does their homework. This company has a big loan coming due next year. Now, I'm not an expert in the hotel business. I'm not an expert in the health care business. But I am an expert in the banking business, and I can tell you this much: No bank has ever foreclosed, and no judge has ever allowed anybody to foreclose in this kind of financial situation. They still have $400 million left to draw on their credit lines. They just replaced management, just brought in a bunch of guys from Red Roof Inns. And they're liquidating all the health care properties. The stock is selling at about 10%-15% of book.

Brett D. Fromson: I always knew you as a fundamentally value-oriented investor.

Marc Perkins: Yeah, I like to think valuation-oriented rather than value. I don't know what "value" means. They say, "Well, is it a value stock or a growth stock?" I was on the board of a university, on its investment committee, and they used to talk about, "Well, we've got this guy over here who's a value investor and this guy over here, who's a growth investor." They both had Intel in their portfolios. Is it a value stock or a growth stock? Is it chocolate or is it peanut butter? The real trick is to be able to understand when a growth stock becomes a value stock. Because value stocks are nothing but companies that used to be growth stocks.

Brett D. Fromson: But how would you define your style?

Marc Perkins: It's valuation. You try to buy stuff cheap. You can call that value, but I like growth stocks. I like fallen stocks. Companies that are selling at much lower valuations than other companies that do the same thing.

Brett D. Fromson: Because they had hiccupped?

Marc Perkins: They had hiccupped. Nobody knows about them. They haven't done a good job promoting their stock. They're located in East Oshkosh instead of Silicon Valley. There can be lots of different reasons. They're small, and the competition is big. They're under the radar screen.

Brett D. Fromson: When you decided to get out, how hard was it to leave?

Marc Perkins: It wasn't hard at all. I had reached a time where it wasn't fun anymore. It just wasn't fun any more. I just bagged it. In fact, I wasn't even sure that this job at Gunther International was going to be a permanent thing. I thought maybe I would just get a handle on this and maybe just do a quick turnaround and then we got into it and found out it was really a job.

Brett D. Fromson: Who, in your view, are the best investors you ever met?

Marc Perkins: Seth Klarman of Baupost.

Brett D. Fromson: Because?

Marc Perkins: Iron-willed discipline and the ability to endure not being a part of the mob and not have it bother him. I think that's it as much as anything, as well as being willing to make sensible but seemingly ridiculous bets.

Brett D. Fromson: Who else?

Marc Perkins: A fellow by the name of Bill Nasgovitz. Bill has the Heartland Value Fund out of Milwaukee. I think he's very, very smart. I think Peter Lynch -- I think Peter's brilliant. Peter really understands how to make money. Jim Palotta is as good as anybody I know. He runs the Tudor Investments hedge fund out of Boston. He has a steel trap for a mind. He knows both sides, he knows the fundamental side, the technical side. He really just devours information. I think he's very good.

These are some of the guys who have been out of favor for the last several years, guys who are going to be proved over time to have not been so dumb.

Brett D. Fromson: Who else?

Marc Perkins: Warren Buffett.

I used to trade with him when I was at Salomon . He was a customer of Salomon back in the early '70s, and I can remember when he was buying bank stocks in 1971, the doggy banks, not the growth stock banks. He was buying Harris Trust. And the Manufacturer's Hanover Trust department called up and said they had a big block of stock in Harris Trust for sale. Buffett had a trader, a fellow by the name of Bill Scott in his office in Omaha. And we called Bill Scott and said, "We got a block of Harris Trust for sale." The stock was around $49 and he said, "I'll pay $47." And so we called Manny Hanny back and told them he said he'd pay $47 and they said, "That's ridiculous, down 2 points. That's crazy." Of course, Harris Trust didn't trade very much, so Buffett was the only buyer around.

So we called Scott back and said, "The seller won't go below the market. They'll sell it for 48.5," and Buffett's response was, "Tell them we're not interested." So, we call Manny Hanny back and say, "There are no bids." "What do you mean no bids?" they say. "Tell 'em I'll sell 'em at 47." So Buffett's guy says, "47 is no good any more. We've gone on to something else and we're just not interested." So the Manny Hanny guy couldn't believe that somebody just walked away. So he now starts calling everybody on the Street trying to sell and the next thing you know, the stock is around 44. And he'd call us back back and ask, "Can you buy it now?" And I would call Buffett back and he would say, "I'll pay 42."

That's his whole deal. Iron-willed discipline. People who know what they know and know what they're good at survive over time.

Brett D. Fromson: What did you make of the collapse of the Nasdaq market in the April-June period?

Marc Perkins: Well, stuff was going on that was really nutty. And I don't mean just high valuation stuff. Here's a revelation for you: Amazon (AMZN:Nasdaq - news - boards) is a store. It's not a computer company. It's not an Internet company. It's a store. That's all it is, it's a retailer. What is the difference between an Internet company and Lands' End (LE:NYSE - news - boards), the catalog company? You order in a different way. And I'll tell you something, until we get a lot more bandwidth, I'd just as soon look through a catalog.

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"You got a grocery store that doesn't make money and it's worth a fortune? Hello? I mean, the whole Internet shopping thing is just a joke."

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It's great if you know exactly what you want, going in. But to browse to shop over the Internet is a pain in the neck. They don't call it the World Wide Wait for nothing. As everybody gets cable modems and DSL, whatever, obviously it will become a lot easier, but you get all these companies today that say they're going to deliver groceries via the Internet. Cut it out, come on. I mean, that's got to be one of the silliest business models ever.

Everybody used to get their groceries delivered. When I was a kid, everybody got their groceries delivered. I used to deliver, and I used to get a nickel tip. That's what I used to do after school. People would call up a local, independent grocer down on the corner and there were three or four kids that used to go down there after school and that's how we would make a little extra money. We would stand there, and they would come out, and they would give us a bag of groceries and a slip that said where it was going and we took it and we delivered it.

Now some guy's got a business that he says is going to be worth a billion dollars because he delivers groceries, because people are too busy to shop for themselves. It's a grocery store. That's all it is. What's the multiple in a grocery store? Eight? Nine? For ones that make money. You got a grocery store that doesn't make money and it's worth a fortune? Hello? I mean, the whole Internet shopping thing is just a joke.

There will be survivors. But the survivors will be companies that have real retailing businesses, and who take those businesses and make them better by also distributing over the Internet. Why? Because when push comes to shove, you have to deliver. I can't quote exactly what the numbers were, but the fulfillment numbers for last Christmas were really what ended it all. When you looked at it and saw what percentage of orders didn't get there by Christmas. It was 30%-40% in most places. Amazon lost a fortune because they got it there by Christmas. It cost them a fortune to get that stuff out the door. The winner's going to be the guy who gets it out the door. The guy who understands the fulfillment business.

Click here for Part 2 of the Marc Perkins chat.

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