Monday, 14 March 2016

Guest post: "Is John Elway a secret Value Investor?"

To continue keeping Financial Orbit fresh I am very pleased to reintroduce a guest author. Harsha Boralessa is a CFA charterholder and a chartered accountant. He has several years of professional experience working with investments involving equity, fixed income, derivatives and private equity in a number of organisations including a European bank, a global asset management company and global accounting firms. He is interested in fundamental bottom-up value investing and how investors' behaviour may create opportunities where an equity's market price will differ significantly from its intrinsic value. He is on Twitter @HarshaBoralessa - and well worth a follow.

Harsha has written a fascinating piece on value investing psychology...and sporting choices which you can find below.  

Chris Bailey
Founder, Financial Orbit Limited
Twitter: @financial_orbit 

"Is John Elway a secret Value Investor?"

by Harsha Boralessa

For those of you who are not interested in the NFL, John Elway was one of the greatest quarterbacks in the NFL. He is in the Hall of Fame and had a storied career with the Denver Broncos winning two Superbowls. Although he graduated from Stanford with a degree in Economics, you may ask, what connection does John Elway have with value investing?

Elway is currently the General Manager of the Denver Broncos, who recently won the Super Bowl in an emotional farewell for Peyton Manning, another all time great quarterback. There was some speculation as to whether Peyton would continue playing but that came to an end this week when he announced his retirement.

The Broncos and Elway were left in a quandry as the quarterback is the most important and highly paid position in the NFL. The contract of their reserve quarterback , Brock Osweiler, was ending and he would become an unrestricted free agent as Denver made the logical choice to use their franchise tag on Von Miller, the Superbowl MVP. A franchise tag is a way for a team to sign a player for an extra year even though his contract has expired.

This gave Osweiler  great leverage as he was able to choose his next team without restriction and usually in the NFL as in the Premier League, this is the team which offers the most lucrative contract. The question facing the Broncos and Elway was how to assess Osweiler's value and whether to keep Osweiler by offering him a sufficiently lucrative contract to stop him from moving to a rival. In the NFL, there are always teams looking to sign quarterbacks and as long as there is one other team with a sufficient need and finances, this leads to a bidding war. In the NFL as in the business world, this scenario generally leads to paying over the odds to secure the asset.

Osweiler had been with the Broncos for four years but had only started seven games, which were all in the last year. His play had been improving, however there were concerns as in the last game he started, he was replaced by Manning due to poor play and Manning took over for the rest of the season.

Furthermore, the NFL operates a salary cap whereby each team is only permitted to spend a fixed amount of money on player salaries every season. Accordingly, there is an imperative for each team to gain the most value in terms of player production for each dollar spent. This has elements of the approach discussed in Michael Lewis' "Moneyball", where the Oakland Athletics , a baseball team with limited funds, competed with higher spending teams by finding players undervalued by the market.

In simple terms, value investing is about evaluating the intrinsic value of an asset and comparing this with its market value, which may differ partly due to the behavioural biases of investors. If an asset's market value is less than its intrinsic value, then there is a potential buying opportunity and if it is greater than its intrinsic value then one should not invest but sell. Value investors have to be dispassionate and withstand behavioural biases or other "noise", which may influence them to act against their best economic interests.

Although Elway was keen to keep Osweiler and did make him a reasonable offer to stay, he was not willing to match any offer that was made by a rival team and Osweiler accepted a $72 million offer from the Houston Texans. Elway said "Whilst we did offer a very competitive and fair long-term contract to Brock, we ultimately had to remain disciplined", according to ESPN. The Broncos continued this discipline by acquiring a new quarterback, Mark Sanchez, on Friday. Sanchez has had a mixed NFL career, so he is unlikely to be the next starter but his current contract is only for a year and is significantly less than Osweiler's, so appears to be good value.

In essence, Elway's view of Osweiler's intrinsic value did not match that of the Texans and he was not pressurised into overpaying to keep him. Ultimately, as with all investments, it is not possible to assess if this was the correct decision at this point in time. Will this scenario be more similar to the RBS led consortium's ' takeover of ABN Amro, where a bidding war with Barclays resulted in overpaying or the fabulous value investing opportunities after the Financial crisis? However as in the words of Kenny Rogers, "You've got to know when to hold 'em, know when to fold 'em, know when to walk away" and Elway just decided to walk away.


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