-
Having first invested in BerkshireHathaway in the
mid-1970s,Chuck Akre has a simple explana-tion for the shares' rise
from $100 to over$105,000. They grew book value at anabove-average
rate for most of that timeabove 20% per year, he says. Thatbecame
the holy grail for me.
Following this holy grail to identifypotential investments has
paid off hand-somely for Akre, who now manages $1.7billion. His
flagship partnership has returnedan annual 21.3% (net) since 1993,
vs.10.7% for the S&P 500.
Akre casts a wide net in his search forcompounding machines,
identifying cur-rent opportunities in such varied industriesas
insurance, gaming, automotive supplyand dollar stores. See page
11
I N V E S TO R I N S I G H T
Chuck AkreAkre Capital Management
Investment Focus: Seeks high-return-on-capital businesses with
excellent futurereinvestment opportunities that are not
fullyappreciated by the market.
ValueInvestor November 30, 2006Alpha from OmegaLee Cooperman
began his storied Wall Street career before many of todayshot fund
managers were born and he hasnt lost a step yet.
As a Goldman Sachs partner andCEO of its asset management
busi-ness in 1991, Lee Cooperman wasfinancially secure, highly
respected on WallStreet and itching to run his own show.It was
time, he says. I chose the nameOmega, the end of the Greek
alphabet,because this would be my last venture.
The second chapter of Coopermanscareer has been as impressive as
the first. HisOmega Advisors, launched at the start of1992, now
manages $5 billion and its flag-ship fund has earned net returns of
16.3%per year, vs. 10.6% for the S&P 500.
Coopermans wide-ranging quest forvalue is currently uncovering
many oppor-tunities, including those in energy, healthcare, Japan
and what he calls quality-growth companies. See page 2
Inside this IssueF E ATU R E S
Investor Insight: Leon CoopermanWhile seeing the overall equity
out-look as respectable, finding unrec-ognized value in Corning,
3M,Omnicare and Transocean. PAGE 1
Investor Insight: Charles AkreBetting on the compounding power
ofPenn National Gaming, Markel,American Tower, OReilly
Automotiveand 99 Cents Only Stores. PAGE 1
A Fresh Look: Tiger vs. BerkshireHis touch appeared to be gone
whenhedge-fund titan Julian Robertsonclosed up shop. It wasnt. PAGE
19
Interview: Julian RobertsonReflecting on his evolving concept
ofvalue, retirement and what hemakes of todays market. PAGE 21
Editors LetterTrying to understand why everyoneisnt a value
investor. PAGE 23
I NVESTM E NT H IG H LIG HTS
Other companies in this issue:AmeriCredit, Bed Bath &
Beyond,
Berkshire Hathaway, CarMax, China
Shenhua Energy, Cisco, Citigroup, Consol
Energy, Crown Castle, CSK Auto,
Gazprom, Lukoil, Microsoft, Mirant,
Mohawk Industries, News Corp., Oracle,
Royal Dutch Shell, Ryanair, Time Warner,
UnitedHealth, Wal-Mart
Compounding InterestCEOs who truly focus on compounding
shareholders capital per share are arare breed. Chuck Akres success
rests on betting big when he finds them.
I N V E S TO R I N S I G H T
Leon CoopermanOmega Advisors
Investment Focus: Seeks companiestrading at significant
discounts to their pri-vate-market values, often due to
inappropri-ately valued growth prospects.
The Leading Authority on Value Investing INSIGHT
www.valueinvestorinsight.com
INVESTMENT SNAPSHOTS PAGE
3M Company 7
99 Cents Only Stores 17
American Tower 15
Corning 5
Markel 14
Omnicare 8
OReilly Automotive 16
Penn National Gaming 13
Transocean 9
-
Your investing strategy can be describedas multi-faceted.
Explain the variouscomponents.
Lee Cooperman: We basically try to makemoney for our investors
in five differentways. First, we take a position on
marketdirection: Do we think stocks are under-valued and likely to
go up or are theyovervalued and likely to go down? Asgood as you
are at picking stocks, if youget the market wrong it can
overwhelmindividual selection.
Second, we spend a fair amount oftime on the asset-allocation
decision,making a determination on what assetclass has the best
prospective investmentreturns 12 months ahead. At the mostbasic
level, were looking at stocks vs.bonds vs. cash, but we also go
deeper intoeach category, investment-grade vs. high-yield bonds,
for example.
Third, our bread-and-butter businessand where weve been quite
successful isin finding undervalued individual stockson the long
side. Fourth, we look forovervalued stocks on the short
side.Finally, we also make macro invest-ments, in currencies,
global fixed incomeand the major international indices.
Many value investors Warren Buffettmost prominently say they
spend littletime thinking about the markets overalldirection. Why
is that an important partof your strategy?
LC: Were not a slave to our market view,but the truth of the
matter is that a risingtide does lift all boats and a falling
tidelowers them. I would suspect evenWarren Buffett has some fairly
clear andstrongly held broader views when hesshort dollars, for
example, to the tune of$19 billion. We just apply the same typeof
thinking when setting our equity-mar-ket exposure.
Steven Einhorn: Virtually all studies showthat about 60% of the
return and volatil-ity of the average common stock is deter-mined
by the movement in the aggregatestock market. So while were
bottom-upstock pickers, we think its important tohave a view of the
economy and the over-all market to help us determine
whichindustries and sectors to emphasize.
LC: There are thousands of mutual fundsthat will happily manage
your money fora management fee of 1% or less. If yourea hedge fund
with the audacity to chargebetween 1% and 2% as a managementfee and
take 20% of the profits, yourclients have the right to expect
somethingmore. What I consider more is thatwhen the markets
overvalued, my clientsexpect me to figure it out and be hedgedand
out of harms way. When the mar-kets undervalued, they want me to
beleveraged to the upside. If the U.S. isuninteresting, they expect
me to findsomething around the world that makessense. Thats why I
want to have diversi-fied capability we have an excellentteam that
is also looking at fixed income,commodities and currencies. Those
areareas, if we do them well, in which wecan produce additive
returns without nec-essarily correlated risks.
Do you consider todays U.S. equity mar-ket overvalued or
undervalued?
SE: Id describe our view of the U.S. mar-ket outlook as
respectable. That means amarket that isnt susceptible to
pro-nounced downside risk and that shoulddeliver a high
single-digit to low double-digit total return over the next 12
months.
What are the factors driving that view?
SE: One is the economy, which we believewill grow modestly over
the next 12-15
I N V E S TO R I N S I G H T : Leon Cooperman
Investor Insight: Leon Cooperman
Value Investor Insight 2November 30, 2006
www.valueinvestorinsight.com
Omega Advisors Leon Cooperman (along with Steven Einhorn, Mark
Cooper, Michael Freedman and David Mandelbaum)describes why he
always has a view on the overall market, why energy is his largest
sector exposure, the worst aspect ofmoney management and why he
sees undiscovered value in Corning, 3M, Omnicare and
Transocean.
Leon Cooperman
The Forest and the Trees
In 40 years on Wall Street, Lee Coopermanhas distinguished
himself both by an abilityto see the big picture as well as to dive
intothe details. He rose through the researchside of Goldman Sachs,
eventually chairingthe firms investment committee and run-ning its
asset management business. Hewas named the #1 portfolio strategist
fornine straight years in Institutional InvestorsAll-America
Research Team survey. At thesame time, the thoroughness of
hisresearch on individual companies is leg-endary to this day, hes
well-known forinsightful and tough questioning of execu-tives on
analyst calls.
At 63, Cooperman shows no sign of lettingup. As he describes it:
I grew up in theSouth Bronx and am a graduate of P.S. 75and Morris
High School. I went to CityUniversity of New York for $24 a
semester. Ithen spent 16 months at ColumbiaUniversity getting an
M.B.A., graduating onJanuary 31, 1967. With a six-month-old
son,National Defense Education Act studentloans and no money in the
bank, there wasno opportunity to go on the obligatory six-month
tour of Europe before going to work. Istarted at Goldman Sachs the
day after Igraduated from business school and Ivebeen working that
same way ever since.
-
months at an annual rate of 2% to 2.5%.We think thats a sweet
spot for the equi-ty market fast enough to deliverrespectable
earnings growth, but slowenough to bring about a moderation inthe
rate of inflation and to keep the Fedfrom tightening. Housing is
clearly in themidst of a very significant downturn,which will take
a percentage point off ofGDP growth, but we think capital
invest-ment in energy and growth from foreigndemand will offset
that and keep theeconomy growing.
We also think inflation is likely tobecome more tame as the
economy slows.The best evidence for that is that
inflationexpectations built into fixed-incomeprices have been
receding in the past sixmonths and are at a 12-month low.
The third driver of our positive marketview is the strength of
corporate profits,which have been terrific. Its amazing thatfive
years into an economic expansion,72% of companies are reporting
positiveearnings surprises. Next year, thoughgrowth will slow, we
think earnings willgrow another 7-9%.
Related to that, the condition of thecorporate sector is
terrific. Returns onequity and profit margins are close torecord
levels, balance-sheet leverage isdown, dividends are growing
10-12%and share buybacks are near a peak. Withall that, we consider
the market to bemoderately undervalued. Absolute P/Esare the lowest
theyve been in 15 yearsand relative to interest rates and
inflation,the market is attractively priced.
LC: To reverse the question, we look atwhat would change our
mind from thisconstructive view. Every bear market,with the
exception of the one followingthe Cuban missile crises in 1962, has
beenbrought on by a recession. We talk regu-larly to companies like
GE and FederalExpress and retailers and the worst youhear is a
possible slowdown in growth,not a recession. Our view would also
like-ly change with a meaningful accelerationof inflation that
brought the Fed backinto play. We dont see that and are oper-ating
under the assumption the Fed isdone tightening for at least six
months.
The third big negative would be a disrup-tion in the energy
supply chain thatcaused oil prices to spike back up to theupper
$70s thats very difficult to pre-dict, but we might see the
beginning ofdemand destruction if that happened.
When the rate of inflation has beenbetween 1% and 3%,
historically the S&P500 multiple on forward earnings
hasaveraged over 17x. Inflation is now in thatrange, but the
current S&P multiple isaround 15x. In this type of
environment,
we think the idea of buying a 10-year gov-ernment bond at a 4.6%
yield makes nosense relative to the stock market.
How is that view translating into yourcurrent asset
allocation?
LC: Were heavily invested, about 82% netlong. Since we started
Omega, our averagenet exposure has been closer to 70%. Wedont short
in order to call ourselves ahedge fund, but when we think we
canmake money at it. With all the liquidityand buyout activity out
there, we haventseen a lot of profitable opportunities onthe short
side with equities. We do thinkfixed income is overvalued, so we
have ashort position on 10-year Treasuries.
How active are you in foreign equities?
LC: Wed like to have more, but we cur-rently have about 15% of
our equityexposure outside the U.S., mostly inWestern Europe and
Japan. We do verylittle in emerging markets after ourexperience
with Russia abrogating itsdebt in 1998 but have positions inChina
Shenhua Energy, the largest coalcompany in China, and Lukoil
and
Gazprom, which we think are uniqueRussian energy companies.
Lukoil, forexample, has reserves equal to Exxons,but trades at
one-sixth the market capital-ization of Exxon.
The gamble in China and Russia is onrule of law. The
fundamentals of the com-panies are outstanding the question
iswhether these countries are committed toopen economies and
capitalistic rewards.
In individual stock selection, what signalsto you that something
is undervalued?
LC: Heres how we think about it: TheS&P 500 companies sell
at 15x nextyears earnings, 3x book value, 11x cashflow, 1.5x
revenues, have an ROE of 17-18% and have anticipated trend
earningsgrowth of 8%. Were looking for compa-nies with equal or
superior growth char-acteristics that sell at discounts to
themarket valuation.
Is it always a relative view?
LC: No, for us to buy something it has tobe absolutely cheap and
also cheap rela-tive to the market.
We use the typical absolute approachesto valuation based on
discounted cashflow, asset values, earnings power toarrive at what
we think a companys truebusiness value is. Publicly traded
compa-nies have essentially two values: the auc-tion-market value,
which is the price any-one pays for 100 or 100,000 shares, andthe
private-market value, which is theprice an informed buyer would pay
for100% control. Were looking for compa-nies where the difference
between thosetwo values is the highest and, ideally,where we can
identify a catalyst forchange. Were also looking for
mispricedgrowth, where our view of the growthpotential or the value
of that growthpotential differs from the markets.
How do you generate ideas?
LC: We have 12 people working on theidea side. We give them
responsibility foran agreed-upon universe of companiesand we expect
them to mine those compa-
Value Investor Insight 3November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
ON SHORTING EQUITIES:
With all the liquidity and buyout
activity out there, we havent
seen a lot of profitable oppor-
tunities on the short side.
-
nies for the opportunities Mr. Marketpresents. They go about
mining thoseopportunities in different ways, but noth-ing goes into
the portfolio without some-ones initials by it and my approval.
When you hire people, you have to givethem enough rope to prove
what they cando and be willing to share in the upsidewith them. At
the end of the year when wereview performance, we look at how
eachanalysts return on capital compares to theopportunities
presented by the group ofcompanies he or she follows. We look athow
they manage drawdowns and risk.Did they make their money broadly or
injust a few names? Did they communicateeffectively? Did they learn
from mistakes?
Are there particular businesses or sectorsthat tend to attract
you?
LC: For the most part, well look at anysector of the market.
Technology isnt atthe top of our lists usually, but we do ownCisco,
Microsoft, Oracle and Corning.With the exception of Corning so
far,which well speak about later, these haveall been very good
stocks for us.
This isnt unique to us, but we wantcompanies with large amounts
of freecash flow, good business dynamics, aproven ability to
profitably reinvest thatcash flow and management
properlyincentivized to do the right thing forshareholders. We
generally focus on busi-nesses that are two-cycle tested,
wheretheyve been through a couple recessionsand have survived
intact.
You generally wont see us buy thingsthat have been up 50-60% we
figuresomebody else already made the money onthose. A company like
[floor-coveringsmaker] Mohawk Industries, which has alot of free
cash flow and a CEO, JeffLorberbaum, who has done a great job
ofreinvesting that cash flow, wed probablyown if the stock was in
the mid-$60s, butnot at the $75-76 at which it trades today.
Do you consider yourself an activistinvestor?
LC: We dont look to go into underper-forming companies and try
to get them to
change their ways, but we have no qualmsabout making our views
known whenthings are being done that we dont agreewith. When [power
wholesaler] Mirant[MIR] announced a tender offer at a 30%premium
for NRG Energy earlier thisyear, we said very publicly that it
makesabsolutely no sense to use auction-marketstock trading at a
big discount to our view
of its value to pay private-market valuefor another company.
[Note: Mirant with-drew the acquisition proposal in June.]
We own Bed Bath & Beyond [BBBY],which is arguably one of the
best retailersin the country, and I have tremendousrespect for the
way they run their busi-ness. But we think theyre too
debt-averseand should take on debt to buy up to25% of their stock.
They have short- andlong-term cash of $1.4 billion withalmost no
debt, while they generate in atypical year $400-450 million of free
cashflow, which is growing. We have a veryopen conversation with
them about this,they just havent listened to us yet.
An example of good activism by oth-ers, I should say is what
happened withKerr-McGee, which has been my best per-former this
year. I couldnt get the compa-ny to see the virtue of buying back
stock,but when Jana Partners and Carl Icahnlaunched a proxy fight,
the companyresponded by shedding assets andannouncing a big share
buyback. A yearlater they announced another $1 billionbuyback on
their own and then ended upselling the company to AndarkoPetroleum
for a big price, well above theprice at which they bought back
stock.Theres no question, and they will tell youthis, that a key
reason they got the pricethey did was by shrinking their cap baseat
the right time.
Sometimes being an activist can takemore effort than its worth.
Four yearsago we gave up on Tenet Healthcare, sell-ing our entire
position at about $35, afterthey made a series of stupid
decisions.The final straw was when they boughtback $1 billion in
stock and said at thesame time that the companys outlookwas too
uncertain to provide earningsguidance. I said to them, I can
respectthe fact that youre not providing guid-ance, but why are you
buying back $1 bil-lion worth of stock if the outlook is
souncertain. Duh! [Note: Tenet sharescollapsed in late 2002 and
currently tradeat around $7.]
What other things prompt you to sell?
LC: The highest-quality reason is whensomething reaches our
price objective.When energy got to be too much of ourportfolio and
some of the companiesstarted hitting our price targets, we sold
afew, like Royal Dutch Shell and [coal pro-ducer] Consol Energy. A
second reasonwe sell, as it was with Tenet, is to cut ourlosses
short if somethings not moving inthe direction we expected. I tell
my peopleto be in touch at least every couple ofweeks with all
their companies, to getwhatever indication possible on howtheyre
tracking versus expectations.
The third main reason to sell is whenwe identify other ideas
with betterrisk/reward characteristics. A recentexample was selling
Time Warner becausewe thought News Corp. was more attrac-tive.
Finally, as we discussed earlier, whenour market view changes, we
sell to makeadjustments in our asset allocation.
Your equity portfolio tends to be quitediversified. Why?
LC: Diversification is an important part ofour risk management.
Average individualpositions range from 1-2%, with thelargest core
positions at 4-5%. In 15 years,weve had three positions that got as
highas 8%, two that worked out very well andone, Tyco, that was a
disaster at the time.With Tyco, we thought the market wasbeing
irrational and were buying on the
Value Investor Insight 4November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
ON BED BATH & BEYOND:
I have tremendous respect for
them, but theyre too debt-
averse and should buy up to
25% of their stock.
-
way down before the scandal really hit.An important percentage
of Omegas
total capital is our own money and werejust trying to do what we
think is intelli-gent in a highly uncertain world. I dontknow how
some of these young hedge-fund guys do it, being 160% gross longand
40% net long. Im not questioninganybody, but if youre running a lot
of cap-ital, to be that gross long you have toeither have enormous
positions where yougive up liquidity or you have to have
anincredible number of positions, too manyto follow effectively.
Our level of diversifi-cation reflects our unwillingness to
makesuch giant bets or to give up liquidity. Wecould liquidate our
portfolio in 48 hours.
Describe the opportunity youre findingin quality-growth
companies.
LC: As I mentioned earlier, we often findopportunity when our
view of the valueof a company's growth prospects differsfrom the
market's, which is the case todaywith some very high-quality
companies.
Michael Freedman: Stocks go up for oneof two reasons: growth or
multipleexpansion. Growth investors who are notprice sensitive are
playing for businessgrowth. Value investors often play formultiple
expansion and are not overlyconcerned with growth. We try to
lookfor situations where you can benefit fromboth that gives you
two ways to win.
Good, growing businesses tend to becheap either because theyre
overlookedor out-of-favor. With our asset size, weremore likely to
put capital to work in high-quality growth companies that are
out-of-favor and in Mr. Markets penalty box.Fortunately,
short-term, momentuminvestors can drive down growth-compa-ny share
prices, providing plenty ofopportunity for those with a
longer-termfocus to buy on the cheap.
Lets talk about one of the specific growthcompanies you see as
out-of-favor,Corning [GLW].
MF: Cornings biggest and highest-profilebusiness is providing
the glass used in
making screens for a wide variety of con-sumer electronics, most
importantly liq-uid-crystal-display monitors and TVs.Consumer
adoption of LCD TVs is nowhitting its acceleration zone, as
pricescome down. I looked up and down theindustrys food chain for
the best way toplay this explosion in consumer adoptionand landed
on two areas supplying theliquid crystal and supplying the glass
forscreens. In each case there are very fewsuppliers and the
manufacturing processis very difficult, making the potentialupside
very interesting as demand grows40-50% per year.
The LCD panel itself is essentially a
sandwich, with two sheets of glass and allthe electronics and
lighting behind it. Theglass Cornings business has to beabsolutely
perfect, with no deviation inthickness or any imperfections
through-out the entire panel, and it has to be ableto withstand
high temperatures in thefabrication process.
Given how hard that is to do, there areonly three main players
in the market:Corning, with 60% of the market, fol-lowed by two
Japanese competitors,Asahi Glass and Nippon Electric Glass.Corning
has been the technology leader,which gives them a pricing
advantageuntil the competitors catch up. Theyre
Value Investor Insight 5November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
Corning(NYSE: GLW)
Business: Manufacturer of glass-basedproducts with applications
primarily in con-sumer electronics, telecommunications,
lifesciences and environmental control.
Share Information(@ 11/29/06):
Price 21.4952-Week Range 17.50 29.61Dividend Yield 0.0%Market
Cap $33.62 billion
Financials (TTM):
Revenue $5.01 billionOperating Profit Margin 15.2%Net Profit
Margin 6.1%
THE BOTTOM LINE
As the market-share and innovation leader, Corning is ideally
positioned to profit frombooming consumer and industrial demand for
liquid-crystal-display glass, says MichaelFreedman. He believes
that at a more appropriate 20x multiple of estimated 2008earnings
of $1.50 per share, the shares within a year should be worth around
$30.
I N V E S T M E N T S N A P S H O T
GLW PRICE HISTORY
Sources: Company reports, other publicly available
information
30
25
20
15
10
5
30
25
20
15
10
52004 2005 2006
Valuation Metrics(Current Price vs. TTM):
GLW S&P 500P/E 28.4 20.4P/CF 33.7 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
Fidelity Mgmt & Research 7.0%Capital Research & Mgmt
4.8%Wellington Mgmt 3.5%Axa 3.1%Barclays Global Inv 3.1%
Short Interest (@ 10/9/06):
Shares Short/Float 1.1%
-
also the most flexible and cost-efficientmanufacturer and their
glass runs up to15% more efficiently through the cus-tomers fabs.
Thats why theyve beenable to maintain market leadership andanother
reason they get premium prices.
What is the market concerned about?
MF: Some of it has been over the timingof seasonal orders, which
I think is irrele-vant. There may be variability in con-sumer and
therefore TV-manufacturer demand, but it has no effect on
longer-term demand for LCD glass.
The market also seems very concernedabout pricing. Every year
the price of LCDglass on a per-inch basis goes down, as istypical
in consumer-electronics businesses.This year the price per-inch
will probablybe down about 15%, which is more thanthe market
expected. I dont consider thata big deal for two reasons. One, a
big partof this years decline came from Asahi andNippon catching up
in quality in certainglass sizes, wringing out some of the pre-mium
Corning was able to command inthose sizes. To the extent the
premium hasbeen wrung out in those products, it cantbe wrung out
again, so theres no reasonto consider the 15% price drop a
trend.
Second, Corning seems to get little cred-it for that fact that
theyve been reducingmanufacturing costs in the mid-teens also.This
highlights one of their primary com-petitive advantages: they spend
10% ofsales on research and development, work-ing on both inventing
the next big thing aswell as driving down costs of
existingproducts. Thats a lot more money onR&D than their
competition can afford.
How attractive do you consider Corningsother business lines?
MF: LCD glass is the major driver today,but I consider the two
other main busi-nesses to be excellent call options for thefuture.
The telecommunications businessis basically a play on more optical
fiberbeing employed. During the Internet bub-ble, a lot of
long-haul fiber was laid, but itcant be taken advantage of until
newshort-haul connections utilizing Corning
products are in place. As demand forInternet video increases,
youre eventuallygoing to need that fiber capacity available.This
business is breakeven now, but iforders picked up it would be very
prof-itable, very quickly.
Their other interesting business ismaking emissions-control
products forcar and truck engines. New environmen-tal regulations
in Europe and the U.S.requiring cleaner-burning diesel enginesin
heavy-duty trucks go into effect on
January 1. The rules basically require ascrubber on the engine
and Corning hasthe best product on the market. Theyrebooking small
revenues now, but havesigned deals that will show up materiallynext
year. Corning believes this can be a$500-600 million revenue
business withinthe next few years, and they tend to
guideconservatively.
More generally, Cornings heavyspending on R&D would suggest
theymay have several blockbuster products intheir labs right now,
from things like solarcells, green lasers or ultracapacitors.
Trading recently at around $21.50, howare you looking at
valuation?
MF: The company trades at about 16xconsensus 2007 earnings
estimates, whichI think are conservative. If you look at 20of the
best name-brand technology com-panies, like Cisco, Nokia and
Microsoft,the median P/E on next years earnings is17.9x and the
median expected long-termannual growth estimate is 14.6%. SoCorning
is trading for a lower multiplewhile its consensus growth estimate
ishigher, at 17.3%.
Looking to 2008, I think the companycan earn north of $1.50 per
share. At the
18-20x multiple a company with thesegrowth characteristics
should have, wehave a target price for next year ofaround $30.
Another blue-chip attracting your atten-tion is 3M [MMM].
Why?
Mark Cooper: 3M is a large industrialconglomerate whose
specialty is utilizingchemistry and materials science for a
widevariety of purposes, often involving apply-ing coatings to some
kind of surface. Theirbest-known products are Post-it notes
andScotch tape, but that division makes uponly about 15% of
revenues. They havesix different business units, serving a
widevariety of consumer, commercial andindustrial markets. For
example, the dis-play and graphics business applies filmover any
type of screen to enhance bright-ness or improve the viewing
angle.
Its very much a company driven byintellectual property. It
generates amongthe highest number of patents annuallyand
BusinessWeek earlier this year rankedit #3, behind Apple and
Google, on theirlist of the worlds most innovative compa-nies. The
fact that its researchers canspend approximately 15% of their
timedoing what interests them is an importantpart of the company
culture and a sourceof its competitive advantage.
Youve said the company is currently mis-understood. What do you
mean?
MC: With all the different business unitsand industries, its
very hard to analyze3M at a micro level. Perhaps thats whythe
market seems so unenthusiastic aboutthe company. I was at an
investment con-ference in New York a few weeks ago andGeorge
Buckley, 3Ms CEO, made a pres-entation. It was supposed to be
mostly aQ&A session, but only two people askeda question and I
was one of them.Afterwards, only one other investorjoined me on the
stage to speak with Mr.Buckley. This is a $60 billion
market-capcompany and I could spend a month withthem and not know
half the detail Idwant to learn about their businesses, butno one
had any questions.
Value Investor Insight 6November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
ON 3M:
That researchers can spend
15% of their time doing what
interests them is a source of
3Ms competitive advantage.
-
The opinions that seem to be drivingthe market price dont match
reality. Forexample, there seems to be an increasingfear that the
companys growth prospectshave diminished, but if we look at the
lastthree years of sales growth, its close tothe long-term average.
The most recentyear sales growth wasnt great, but I dontat all
consider that a permanent trend,primarily due to growth potential
over-seas, particularly in Asia. The companycurrently gets just
over 60% of revenuesfrom outside the U.S. that should be70% within
the next five years. Im con-fident they can at least hit their
overalltarget of 8% annual organic sales growth.
Theres also concern that the companywill overemphasize growth at
the expenseof margins. I think that concern is exag-gerated for a
few reasons. One, theyregrowing incrementally faster overseas,where
theyve historically earned highermargins. I also believe theres
consider-able inefficiency in their manufacturingand logistics
operations. Over 50% of theproducts 3M sells go through at
leastthree of their factories, which is shocking.Attacking those
inefficiencies and takingcosts out will obviously benefit
margins.
Despite these issues, margins are cur-rently at all-time highs
gross marginsare over 50% and EBITDA margins are
close to 30%. Even if the company didsacrifice some margin to
grow faster incertain areas or devote even more thanthe current
5-6% of revenues to R&D,that would likely be a positive from a
net-present-value perspective.
How is the markets seeming lack ofenthusiasm showing up in the
share price,which is currently around $81?
MC: Almost every valuation metric todayis at a multi-year or
all-time low, whichcontrasts with the growth potential andthe
returns on tangible capital this com-pany earns, which are
consistently over50%. The P/E is close to a 15-year
low,price-to-book a 10-year low, price-to-sales a six-year low and
the dividendyield, at 2.3%, is the highest its been ineight
years.
If the company does just what the mar-ket expects, which is to
earn $5 per sharenext year, I believe they deserve a 20x
P/Emultiple, which is appropriate for a busi-ness that should
produce consistent 15%annual growth in earnings per share
whilegenerating extraordinary returns on capi-tal. That puts our
target price next year ataround $100. If 3M does what we believeit
can do over time on the growth side,the upside is much more than
that.
LC: One thing Id add here is that the com-pany has a
ridiculously unleveraged bal-ance sheet it ought to buy back $2-4
bil-lion of common stock immediately at cur-rent prices. One reason
we own it is thatwe expect a very significant cap shrink.
Tell us about one of your current health-care bets, Omnicare
[OCR].
David Mandelbaum: Omnicare is thenations leading provider of
pharmacyservices to the long-term-care industry,primarily nursing
homes. They have cen-tralized dispensing and packaging facili-ties
and also provide a variety of servicesbeyond just filling
prescriptions thingslike making sure people are taking theirmeds
and arent having any adverse druginteractions. After buying
NeighborCarelast year, they have approximately 50%
Value Investor Insight 7November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
3M Company(NYSE: MMM)
Business: Diversified conglomerate spe-cializing in applying
chemistry- and materi-als-science-based solutions to
consumer,commercial and industrial needs.
Share Information(@ 11/29/06):
Price 80.9852-Week Range 67.05 88.35Dividend Yield 2.3%Market
Cap $59.63 billion
Financials (TTM):
Revenue $22.47 billionOperating Profit Margin 22.7%Net Profit
Margin 15.7%
THE BOTTOM LINE
Market concerns over diminished growth prospects and margin
pressures areoverblown, says Mark Cooper, who expects overseas
growth and cost savings to fuelconsistent 15% annual earnings
growth. At a 20x multiple of the consensus 2007EPS estimate of $5
per share, he believes the shares are worth at least $100.
I N V E S T M E N T S N A P S H O T
MMM PRICE HISTORY
Sources: Company reports, other publicly available
information
100
80
60
100
80
602004 2005 2006
Valuation Metrics(Current Price vs. TTM):
MMM S&P 500P/E 17.7 20.4P/CF 13.2 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
State Street Corp 7.4%Barclays Global Inv 3.0%Vanguard Group
2.6%Fidelity Mgmt & Research 2.1%Capital Research & Mgmt
2.0%
Short Interest (@ 10/9/06):
Shares Short/Float 0.7%
-
market share, far ahead of PharMericaand Kindred Pharmacy, which
now them-selves are merging into a new, independ-ent company.
This is a business that is all about scaleand market share.
Ominicare has cost,price and distribution advantages frombeing #1,
which gives them superiorEBITDA margins in the 11-12%
range.PharMericas are around half that.
The stocks been a bit of a disaster thisyear, off more than 35%
to a recent $39.What are the primary reasons?
DM: Several things have been weighingon the stock. First, the
industry is under-going a dramatic transition. Omnicarehad
previously been largely a Medicaidprovider, but this year, with the
newMedicare Part D program for prescriptiondrugs, all seniors who
qualify for bothMedicaid and Medicare much of thenursing-home
population are now cov-ered under Part D. With that, instead
ofbeing price takers of state Medicaid agen-cies for drugs and
dispensing, Omnicarenow negotiates separately with all the pri-vate
Part D plans, such as HMOs or phar-macy-benefits managers that are
licensedunder Part D. While change causes uncer-tainty, I generally
look at this as a long-term positive. As the only truly
nationalprovider, Omnicare has been able to getbetter pricing from
the large private plansrelative to what it had under Medicaid.
Second, theres been an overhang prob-lem because of some
investigations intoOmnicares practices. The state ofMichigan went
after them over billingerrors it discovered and the federal
govern-ment and 42 states sued them over someirregularities in
documenting the substitu-tion of generics. Both of these have
recent-ly been settled, and while the market hastended to view
these as potentially indica-tive of a larger problem, we generally
con-sider these to be isolated situations that areinevitable when
operating in such a com-plicated regulatory environment.
The third thing worrying the market isa pricing dispute with
UnitedHealth.United covers about one-third of the dual-eligibles
now getting their prescriptions
paid under Part D. Omnicare negotiatedgreat rates with United,
but then Unitedacquired PacifiCare, with whichOmnicare had a less
attractive contract.United then started moving its dual-eligi-ble
members over to the PacifiCare con-tract, which, if it sticks,
would result in a40-cent hit to Omnicares annual earningsper share.
Omnicare has sued them overthat, and while Im not counting on it
aspart of my investment thesis, I think itsmost likely there will
be a positive resolu-tion of this for Omnicare, which would bea
great catalyst for the stock.
Fourth, the company has been hit withsignificant extra costs
which we clearly
see as non-recurring in the second halfof this year, due to a
fire that closed oneof its two main repacking facilities.
Last, but not least, Democrats takingover Congress has been a
negative forhealthcare stocks of all kinds.
What upside do you see for the shares?
DM: In investing in any business, but par-ticularly relevant to
healthcare, you makemoney when you can separate the noisefrom the
fundamentals. When the funda-mentals are strong and improving, as
theyare with Omnicare, the noise can createan exceptional
opportunity.
Value Investor Insight 8November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
Omnicare(NYSE: OCR)
Business: Provider of pharmaceuticals andpharmacy services to
long-term healthcareinstitutions such as nursing homes, primari-ly
in the United States and Canada.
Share Information(@ 11/29/06):
Price 39.1152-Week Range 35.30 62.50Dividend Yield 0.2%Market
Cap $4.75 billion
Financials (TTM):
Revenue $6.51 billionOperating Profit Margin 7.5%Net Profit
Margin 2.5%
THE BOTTOM LINE
David Mandelbaum doesn't believe the recent events weighing on
Omnicare sharesthreaten the company's strong and improving business
fundamentals. Once the marketsees through all the clouds, he
expects the shares to return to their historical 17xmultiple of
forward earnings, which would result in a share price of at least
$54.
I N V E S T M E N T S N A P S H O T
OCR PRICE HISTORY
Sources: Company reports, other publicly available
information
80
70
60
50
40
30
20
80
70
60
50
40
30
202004 2005 2006
Valuation Metrics(Current Price vs. TTM):
OCR S&P 500P/E 28.8 20.4P/CF 16.9 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
Fidelity Mgmt & Research 14.6%Glenview Capital 7.2%T. Rowe
Price 4.7%JPMorgan Chase 3.5%Barclays Global Inv 3.1%
Short Interest (@ 10/9/06):
Shares Short/Float 8.5%
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Omnicares earnings power is verystrong. Theyre getting higher
margins ongenerics, which are taking market share.Other than with
UnitedHealth, better pric-ing is locked in for next year. We see
sub-stantial cost-saving opportunities from theNeighborCare
acquisition and efficiencyinitiatives now underway. There are
alsohundreds of acquisition opportunities forthem among smaller
players who cantcompete in an increasingly scale-drivenbusiness,
and such deals have generallybeen extremely accretive.
We estimate on the low end theyllearn $3.20 per share next year,
versus theWall Street consensus of $2.90. Theycould do even better
than our estimate ifthe United case gets settled in their
favor.
So the shares are trading at just over12x next years earnings,
vs. an historicalaverage of around 17x. Once the marketsees through
all the clouds and startsfocusing on how well the company is
posi-tioned and the mid-teens annual growth inearnings it can
produce, we see no reasonthis shouldnt return to its historical
mul-tiple. At 17x, this is a $54 stock.
What are the biggest risks here?
DM: If were going to be wrong, its mostlikely to be from some
market change, sayMedicare cutting Part D rates or plansponsors
squeezing them on pricing. Wedont believe either is going to
happen.
Youre still heavily invested in energy.Describe one of your
favorites in the sec-tor, Transocean [RIG].
LC: We do still like energy, which current-ly makes up about 15%
of our portfolio.We find energy-sector valuations to beattractive
and expect high free-cash-flowlevels to help fund buybacks,
dividendincreases and the de-leveraging of balancesheets. Having
come down from specula-tive levels of a few months ago, we thinkan
oil price of $50-60 per barrel is funda-mentally defensible and
that the secularsupply/demand environment is favorable,with global
oil demand growing up to 2%per year, while global supply growth
is1.5% or less. Despite extremely high oil
prices, youre not seeing production growat the majors its
actually declining.
Oil prices are at a level thats morethan sufficient to generate
good capitalspending in the sector, which particularlybenefits
services firms like Transocean.They own about 35% of the worlds
sup-ply of fifth-generation deep-water drillingrigs and have the
most-sophisticatedequipment, the best technology and
thebest-trained personnel to man the rigs.And, there is an acute
shortage of supplyin these rigs, which will not change untilaround
2010. Thats an excellent combi-nation: Youve got the best mousetrap
intown, and mousetraps are in short supply.
As weve seen recently with the largediscoveries in the Gulf of
Mexico, deepwater, which is economic at prices as lowas $40 per
barrel, is where all the devel-opment prospects are. Given that
weagree with Boone Pickens who made allhis money trading oil when
he says heexpects to see $70 oil again before he sees$50, we think
Transocean trading on 50-cent moves in the price of oil is
silly.
Isnt the rig business famously prone toovercorrecting on the
supply side?
LC: Were the first to acknowledge that,but given that youre not
going to see new
Value Investor Insight 9November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
Transocean(NYSE: RIG)
Business: Global provider of offshorecontract-drilling services
for oil and gaswells, with a focus on deep-water
andharsh-environment drilling.
Share Information(@ 11/29/06):
Price 78.5152-Week Range 62.62 90.16Dividend Yield 0.0%Market
Cap $22.96 billion
Financials (TTM):
Revenue $3.47 billionOperating Profit Margin 33.2%Net Profit
Margin 26.4%
THE BOTTOM LINE
As the leader in deep-water drilling services, Transocean has
the best mousetrap intown, and mousetraps are in short supply, says
Lee Cooperman. Just by gettingcredit from the market for the $12
billion in cash earnings he expects from backlogorders through
2010, he believes the shares are worth at least $100.
I N V E S T M E N T S N A P S H O T
RIG PRICE HISTORY
Sources: Company reports, other publicly available
information
100
80
60
40
20
0
100
80
60
40
20
02004 2005 2006
Valuation Metrics(Current Price vs. TTM):
RIG S&P 500P/E 27.2 20.4P/CF 16.7 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
Capital Research & Mgmt 5.2%Davis Selected Advisers
3.2%Fidelity Mgmt & Research 3.0%State Street Corp 2.8%Vanguard
Group 2.8%
Short Interest (@ 10/9/06):
Shares Short/Float 4.9%
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deep-water rigs in any volume before2010, we think that risk is
already morethan in the stock.
Another risk would be if the holes startcoming up dry. These
rigs lease out for$500,000 per day, so if theyre not find-ing oil,
theyre obviously not going todrill. We see no evidence that will be
aconstraining factor.
At around 78.50, the shares are off near-ly 15% from their May
high. What doyou think theyre worth?
LC: Given the backlog from now until2010 all from orders by
triple-A anddouble-A companies and countries theirbusiness is
reasonably locked. They havea funded backlog of over $20
billion,which will convert into about $12 billionof cash in the
next three and a half years.That $12 billion in cash is about $40
pershare. Just getting credit for the cash flowthats already
basically in the bank, webelieve the shares are worth at least
$100.
Supporting the price is the fact thattheyre using some of their
enormous freecash flow to buy back shares. Theyveauthorized $4
billion in buybacks andhave already bought in $2.6 billion worthso
far this year.
Are you making any important macrobets, as you described them
earlier?
LC: We have a position right now inJapans Nikkei index. The
S&P 500 is uparound 12% this year, Europe is up 13-14% and the
Nikkei is so far down about2%. Japan has significantly lagged
majorworld markets, yet they have a cheap cur-rency, which is very
positive for the profitoutlook, and they have a
0%-interest-ratepolicy, which is very positive for
multiplevaluations. You have a growing economywith world-class
companies, while corpo-rate profit margins are low relative to
therest of the world, so theres more room forimprovement. Youre
coming off a 15-year bear market and common sensewould tell you
theres more to go on theupside than two or three decent
years.Finally, given the proximity to China, Iexpect more to fall
off Chinas plate intoJapan than into the U.S.
Youve been at this for 40 years. Do youexpect to keep it up for
another 40?
LC: I still enjoy the game, making bets onsomething other people
dont see andhaving Mr. Market prove me right.
Ive said since I started in the business
that three things would get me out of it.One is a medical issue
and, knock onwood, I feel fine and have a lot of energy.Second is
if I stopped delivering perform-ance that is acceptable. My
investor baseis very committed to me and they knowme personally I
dont want anyone stick-ing with me unless Im delivering
highlycompetitive performance. Third, Ill stopif I dont still enjoy
it. Thats the only onethats becoming more of challenge.
Why?
LC: The people side of things can be dif-ficult. Im unusual in
this business. I spentmy career at one firm before setting outon my
own and have always been inter-ested in being long-term selfish,
not short-term selfish.
Ive hired people for $50,000 a year,three years later paid them
a multi-mil-lion bonus and then had them quit tomake more money.
Its pay me, pay me,pay me if I do well and if I lose money, Illsee
you later. I cant bemoan the waythings are, the system has treated
me verywell. But people should recognize that itsa vacuum in
nature, not some God-givenright, thats created the opportunity
tomake the money that we do. VII
Value Investor Insight 10November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Leon Cooperman
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I N V E S TO R I N S I G H T : Charles Akre
Your investment philosophy has beeninfluenced as much by Warren
Buffett theCEO as by Warren Buffett the investor.Describe how that
came about.
Charles Akre: I was fascinated by JohnTrains The Money Masters
in the mid-1970s, the first chapter of which was onWarren Buffett.
I became the best studentof Buffett I could and first
boughtBerkshire Hathaway shares when it had a$100 million market
cap. From that happyexperience, it became clear to me that thebest
way to see if a business is addingshareholder value is by the
growth in itsbook value per share. You have to makeadjustments for
different industries or forissues with GAAP accounting, but
Imlooking for growth in the companys trueeconomic value per share
over time.
What surprises me today is the numberof CEOs and CFOs who are
focused onother things growth in new stores or theshare price or
their options. When I meetwith management, I dont ask aboutgrowth
in book value because I want to seeif they get there on their own.
Few do.
I look at it this way: The average annu-al total return from
equities over long peri-ods of time has been around 10%. Whenyou
clean up the accounting, the realreturn on equity [ROE] of American
busi-ness averages in the low teens. So our con-clusion is that a
stocks return will approx-imate the companys ROE over time, givena
constant valuation and absent distribu-tions. So we choose to swim
in the pool ofcompanies where the returns are a wholelot better
than average, in the 20% range.
Historical returns obviously dont guaran-tee future returns. How
do you separatethe future winners from the has-beens?
CA: We focus on three things: businessmodel, people and
reinvestment capability.
In companies earning abnormalreturns, theres something unique
going onand we want to understand what it is,why it exists and
whether its sustainable.Were trying to find businesses that
havegreat moats, which translates into greatreturns on capital.
Moats are fairly rarebut come from a variety of things, such
asregulation, intellectual property, sustain-able cost advantages
and superior man-agement. True moats give you more confi-dence in
projecting future performance.
We next focus on management. Im ata stage in my career where Id
say humanbehavior is the most important determi-nant of a businesss
long-term success. Idont care how smart an analyst you are,you cant
really know whats going oninside a business. We want to invest
notonly in highly capable managers, but alsothose with clear track
records of integrityand acting in shareholders best interest.Ive
found that when a manager puts hishands in shareholders pockets
once, hesmuch more likely to do so again.
Do you ever buy a great business with anot-great management,
expecting change?
CA: We generally dont invest in brokenbusinesses that need to be
straightened outor bad people that need to be thrown out.Its just
not what we do.
Our third focus is related to the firsttwo: Because of the
nature of the businessand the skill of management, were look-ing
for companies that can reinvest whatwe expect to be excess cash in
a way thatearns unusually high rates of return. Thiswas the case
with Berkshire Hathaway,which created a compounding machine.
How does valuation come into play?
CA: On top of everything we apply oursophisticated valuation
methodology,
Investor Insight: Charles Akre
Value Investor Insight 11November 30, 2006
www.valueinvestorinsight.com
Akre Capitals Charles Akre describes why moats are so central to
his investing style, why he's not big on diversification, whyhigh
valuation is rarely the reason he sells and why he sees
undiscovered value in Penn National Gaming, Markel Corp.,American
Tower, O'Reilly Automotive and 99 Cents Only Stores.
Charles Akre
Long and Winding Road
Having earned an English Literaturedegree from American
University, ChuckAkre took a practical approach to his inde-cision
about a career: I took a series ofvocational aptitude tests which
indicated Ishould be a stock broker or stock analyst,he says. I
truly didn't know the differencebetween the two then.
Starting as a retail broker at Johnston,Lemon & Co. in 1968,
Akre over 21 yearsthere became a shareholder in the firm,director
of its research department andCEO of its investment-management
divi-sion. He started Akre Capital in 1989 tomanage separate
accounts and a hedgefund and teamed in 1997 with Friedman,Billings,
Ramsey & Co. to launch the FBRSmall Cap mutual fund, which he
stillmanages and which earns a five-star rat-ing from
Morningstar.
Akre now works out of an office in rusticMiddleburg, Virginia,
not far from his farmat the foothills of the Blue RidgeMountains. I
had an atypical start in thisbusiness and it's taken a long time to
getto where I am now, says Akre. Curiosity,hard work and more than
a little luck goesa long way.
-
which is basically Were not willing topay very much. We
typically buy compa-nies with higher returns on capital,
bettergrowth, stronger balance sheets and lowerempirical valuations
than the overall mar-ket. We think its intuitive that if we get
allthese right, our return should be higherthan that of the market,
with what webelieve is a lower level of risk than themarket.
The opportunity to buy usually comesdown to a significant
diversity of opinionin the market. Its good for us when WallStreets
opinion differs from ours, whichallows us to buy at attractive
valuations.
We really dont pay that much atten-tion to why something is
undervalued. Ifwe buy companies in which shareholderscapital
compounds at a 20% rate ofreturn over a reasonable time period
andwe pay a below-average multiple for it,our investors will do
extremely well.
How would you define your circle ofcompetence?
CA: We focus on service businesses, ingeneral, because the fixed
assets requiredto produce revenue are smaller. Ive donewell over
the years in recreation and enter-tainment businesses,
property/casualtyinsurance, and banks and other
financialinstitutions. We have larger investmentstoday in retail
than weve had in the past theyre relatively easy to
understand,which is key for me.
Do you have any cap-size restrictions?
CA: Its axiomatic that when businessesare smaller, the
opportunities for com-pounding at a high rate are greater, so wemay
be somewhat more likely to be insmall- or mid-caps.
I would say I dont get overly con-cerned with how my portfolios
are catego-rized. Our mutual fund [the FBR SmallCap fund] was
originally called a valuefund, then it was a core fund and nowit
shows up sometimes as a growth fund.Through all that, we havent
changed any-thing we do since day one the notionthat growth is a
creator of value is animportant part of how we invest.
Describe the distinction you makebetween what you call core and
work-bench positions.
CA: Ive never been so disciplined that Ihold off buying until
100% of the work isdone. A workbench position gets builtinto a core
position only when we have lit-tle or no question about the
business, peo-ple and reinvestment opportunities. Ittakes time to
learn how the businessmodel really behaves and Ive also found
that it usually takes a long time to under-stand when management
is really good.Many of the times I thought I knew rightaway, I was
dead wrong.
An example of a workbench holdingthat has been that way for some
time isAmeriCredit [ACF], a sub-prime autolender we bought in 2002.
We got into itafter they had some credit problems andthey changed
their accounting from gain-on-sale to more cash-based, making
theirGAAP earnings nearly disappear. Webought originally around $7,
down to aslow as $3, and theyve done a great job ofgetting the
business back on track. [Note:AmeriCredit shares currently trade
at$23.50.] But Ive never upgraded it to acore holding because Im
still uncertainhow their customers will behave in a
morecredit-restricted environment. Its a busi-ness-model issue that
keeps me from fullycommitting to it as a core holding.
Your have 65% of your hedge fund port-folio in the top seven
holdings. Why soconcentrated?
CA: If I didnt have partners, the concen-tration would be even
higher. You knowhow much of Warren Buffetts partnershipwas in
American Express when he bought
it after the DeAngelis salad-oil scandal?40% or so. [Editors
Note: In the early1960s, commodities trader Tino DeAngelisattempted
to corner the market for soy-bean oil, which was used in salad
dressing.His elaborate scam involved taking outloans many from an
American Expresssubsidiary against what turned out to
benon-existent soybean-oil inventory. Whenthe fraud was uncovered,
AmericanExpress suffered significant losses on theloans, driving
down its share price.]
If you think about individual wealthcreation in this country, it
almost alwayscomes from a single asset. A companycompounding
capital at way above-aver-age rates, when I have great
confidencethat will continue and the valuation ismodest, I want to
own a lot of that. Therationale is that simple.
Tell us about your largest holding, PennNational Gaming
[PENN].
CA: Penn National is primarily in thebusiness of operating
slot-machine venues on land and on riverboats in
thirteenjurisdictions around the country. Theyreonly in regional
markets, with no positiontoday in Las Vegas or Atlantic City.
Theyalso have racetrack licenses in WestVirginia and Maine.
When we first got involved with thecompany ten years ago, it was
mostly inthe off-track betting business, which hadvery little
reinvestment opportunity. Thatled them to get into running slot
machinesat racetracks and then buying more tradi-tional casinos.
They have an excellent his-tory of acquiring casinos and
makingimprovements in their return on assets.
Whats attractive about the business?
CA: I like that they see their profits incash, every day. Once
venues are estab-lished, they benefit from barriers to entryfrom
the strict licensing issues surround-ing gaming. On the demand
side, its driv-en by human nature and the fact that
largedemographic groups see playing the slotsas three or four hours
of entertainment,for which theyre more than willing to pay$50 to
$100. Theres a lot of activity,
Value Investor Insight 12November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Charles Akre
ON CONCENTRATION:
A company compounding capi-
tal at way above-average rates
when the valuation is modest, I
want to own a lot of that.
-
camaraderie in going with friends, andpretty good food. Thats an
attractivevalue proposition for many people.
All of this makes it an inherently high-return business. In the
ten years weveowned Penn stock, book value has com-pounded at more
than 40% per year.
Whats driving future growth?
CA: With existing assets, they continue todo a great job of
expanding when theycan. In Charles Town, West Virginia, theystarted
with a racetrack and 154 slotmachines and now have 4,200 slots,
withapproval to go to 6,000. In
Lawrenceburg, Indiana, across fromCincinnati, theyre adding a
new riverboatand parking garage to an existing venue.
Many existing assets are relativelyfinite, though, so theyll
have to acquiremore. They continue to make selectiveacquisitions of
individual properties and Isee several public companies that
wouldbe great fits, at the right time. If theopportunities dont
materialize, theyllhave a tremendous amount of capital toshrink the
share base.
This is a perfect example of where myconfidence about
reinvestment potentialhas a lot to do with management. I remem-ber
meeting Peter Carlino, who is still the
CEO, in the 1990s in Boston. I could see afew things right away,
including that hewas very ambitious and had a high level ofself
confidence. His background was inreal estate development, so I knew
hisambition would likely result in his takingon a lot of debt. But
one thing that stuckwith me from that conversation was howin all
his real-estate deals, hed never hadhis wife on a note. Thats
almost impossi-ble to do as a small developer the bankswant your
first child. It told me he had anacute sensitivity to risk. Over
time, as hemade acquisitions and built the company,that sensitivity
has translated into veryhigh standards for the returns he
requiresfor the risks he takes.
Hasnt Penn been particularly generouswith stock options?
CA: Theyve given options at a good clipand Peter takes the most,
which I dontagree with, but he and his family are thelargest
shareholders and thats whattheyve chosen to do. It doesnt take
awayfrom the fact that hes created enormousvalue for all
shareholders over time.
With the shares currently around $37,how are you thinking about
valuation?
CA: The shares trade at 11x our $3.40estimate of 2007 free cash
flow per share thats after all maintenance capitalspending as we
understand it. If were cor-rect that the company can continue
tocompound book value at a high rate 20% or greater over the next
five yearsand we only have to pay 11x to get it, likeI said, well
do very well. Thats why thisis nearly 20% of my portfolio.
What are the biggest risks you see here?
CA: Gaming revenue to various jurisdic-tions is like crack
cocaine they alwayswant more so the risk is that taxes willkeep
going up on casino revenue, as theyhave in Illinois, for example.
In some cases,local and state taxes are as high as 50%.
New jurisdictions will also open up,bringing some new
competition to existingvenues. I just assume there will always
be
Value Investor Insight 13November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Charles Akre
Penn National Gaming(Nasdaq: PENN)
Business: Operator of casino and horse-racing facilities, with a
primary focus on slotmachines. Currently in 13 jurisdictions,though
not in Atlantic City or Las Vegas.
Share Information(@ 11/29/06):
Price 37.3052-Week Range 29.48 43.83Dividend Yield 0.0%Market
Cap $3.17 billion
Financials (TTM):
Revenue $2.22 billionOperating Profit Margin 21.8%Net Profit
Margin 7.3%
THE BOTTOM LINE
Through organic growth and timely acquisitions, Chuck Akre
expects Penn National tocontinue expanding its book value per share
by at least 20% annually over the nextfive years. Trading at only
11x his $3.40 estimate of 2007 free cash flow per share, heexpects
the share price to compound at least as quickly as book value.
I N V E S T M E N T S N A P S H O T
PENN PRICE HISTORY
Sources: Company reports, other publicly available
information
50
40
30
20
10
50
40
30
20
102004 2005 2006
Valuation Metrics(Current Price vs. TTM):
PENN S&P 500P/E 20.4 20.4P/CF 11.6 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
Fidelity Mgmt & Research 11.7%Akre Capital 8.5%Friedman,
Billings, Ramsey 4.7%Bamco 3.9%Munder Capital 3.3%
Short Interest (@ 10/9/06):
Shares Short/Float 3.8%
-
new competition, as there has been for thepast 10 years. While
thats a risk, its alsoan opportunity for an experienced opera-tor
like Penn to open up new markets.
Why is Markel Corp. [MKL], anotherlong-time holding, still
attractive?
CA: Weve actually owned Markel since1990. They operate primarily
in whatscalled the E&S (Excess & Surplus)insurance market,
covering hard-to-placerisks that arent included in the
standard,regulated forms that exist in every state.They have more
than 90 different lines ofinsurance, including things like
liabilityfor summer camps, earthquake and hurri-cane protection and
professional liabilityfor physicians who have had drug andalcohol
problems. Not surprisingly, theytend to have very strict
underwriting con-ditions and premium pricing.
Their business is no different thanmine: it comes down to people
and howwell they put business on the books thatearns an
underwriting profit. The proper-ty/casualty business has been
plagued bylarge companies driven by volume ratherthan
profitability, who expect to morethan offset underwriting losses
withinvestment profits. Markel only writesbusiness for which they
expect to make anunderwriting profit.
In underwriting this way, it allowsthem to be more aggressive
with theirinvestments. They now have 75% ofshareholders capital
invested in equities,with the expectation that has been borneout by
experience that theyll have high-er investment returns than those
whoinvest more in fixed-income. [Note:Markels equity portfolio is
managed byThomas Gayner, whose interview was fea-tured in the May
26, 2006 issue of VII.]
What growth in annual book value areyou counting on here?
CA: Because the company has a history ofunderwriting at a profit
and earning excessinvestment returns, it has an unusual bal-ance
sheet. Its gearing ratio is around3.6x, meaning they have 3.6
dollars in theinvestment portfolio for every dollar of
book value. Given that, only a 5% annualafter-tax return on
their portfolio results inan 18% increase in book value per
share.If you put underwriting profits on top ofthat which theyve
achieved in all butthree or four of the past 20 years plus atrack
record of doing better than 5% after-tax on the portfolio, you can
easily seethem returning over 20% per year.
Will they need acquisitions to grow?
CA: They may have to acquire premiumsto have the type of
reinvestment returnsId like to see. That could come frominvesting
in people to build lines of busi-
ness or from making acquisitions. Youcould argue that given the
difficultiestheyve had with their last big acquisition[of Terra
Nova, a European insureracquired in 2000], theres some risk inhow
well theyll do with that. I think itsvery unlikely youll see them
do anotherdeal that plays out like that.
Markels shares have been on quite aroll, up 40% in the past year
to a recent$444. Do you still see great upside atthis price?
CA: Underwriting profits this year willlikely be anomalous, as
the company got
Value Investor Insight 14November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Charles Akre
Markel Corp.(NYSE: MKL)
Business: Underwriter and marketer ofprimarily Excess and
Surplus insurancepolicies, covering less-traditional risks
notincluded in standard state insurance forms.
Share Information(@ 11/29/06):
Price 444.4052-Week Range 307.41 456.25Dividend Yield 0.0%Market
Cap $4.29 billion
Financials (TTM):
Revenue $2.45 billionOperating Profit Margin 24.9%Net Profit
Margin 16.1%
THE BOTTOM LINE
Chuck Akre believes Markel's underwriting discipline and skill
in producing excessinvestment returns positions it to continue
compounding its book value per share inthe 20% annual range. Given
such growth prospects, he says, the shares are veryattractive at
only 11x the $40 per share increase in book value he estimates for
2006.
I N V E S T M E N T S N A P S H O T
MKL PRICE HISTORY
Sources: Company reports, other publicly available
information
500
400
300
200
500
400
300
2002004 2005 2006
Valuation Metrics(Current Price vs. TTM):
MKL S&P 500P/E 21.3 20.4P/CF n/a 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
Ariel Capital 12.4%Davis Selected Advisers 4.6%Akre Capital
4.0%Fidelity Mgmt & Research 4.0%T. Rowe Price 3.5%
Short Interest (@ 10/9/06):
Shares Short/Float 2.6%
-
big price increases in hurricane areas,while hurricane losses
have been almostnon-existent. But if you combine thoseprofits and
the marked-to-market netinvestment gains, we expect to see
bookvalue increase by around $40 this year. Soeven the current
stock price is only about11x what we would call this years
eco-nomic earnings, which we expect to com-pound over several years
in the 20%range. As with Penn National, well getwealthy putting our
money to work insuch a proposition.
American Tower [AMT] is also up strong-ly this year. Why are you
still high on it?
CA: The business model here leasingwireless-communications tower
capacityto operators like Cingular and Verizon is extraordinary.
Once a tower is up andhas enough tenants to already operate ata
terrific operational margin, revenuefrom the additional fractional
tenant isadded at about a 90% gross margin.
As with gaming, this is a business withhigh regulatory barriers
to entry.American Tower is building towers, butits hard to get it
done on a jurisdiction-by-jurisdiction basis and even harder
foranyone new to the business. When a newtower does go up, it makes
little sense forsomeone to come along and put one nextto it, even
if they could get approval.
Wireless technology is evolvingbeyond voice toward increased
transmis-sion of video and data. Youve had therecent sale of a
tremendous amount ofwireless spectrum and companies likeCraig
McCaws Clearwire building anationwide wireless broadband
network.All of these things currently need networkground antennae
to be efficient, whichsignificantly increases demand for
towercapacity. While its difficult to cite a sin-gle,
unutilized-capacity number forAmerican Tower, theyre adding
tenantsat a rapid clip and capacity is not yet aconstraining
factor.
Another thing we like about the busi-ness is that ongoing
maintenance capitalspending is actually very low.
Customersgenerally pay for most of the technologyupgrades.
How is the competitive environmentchanging?
CA: The largest number of towers are stillowned by the carriers
and small privateowners. Its an asset-deployment issue forthe
carriers and they have been net sellersof towers to the independent
companieslike American. Thats not to say Americantries to buy
everything thats on the mar-ket theyve been very smart in
makingfinancial judgments on assets to buy.
Crown Castle recently agreed to buyGlobal Signal, another big
player in themarket, and will now be the largest inde-pendent,
passing American. Americans
management points out that about 65%of Global Signals assets
were formerSprint assets which were on the market and they thought
overpriced a year anda half ago for $1.6 billion. Now CrownCastle
is paying nearly $6 billion for all ofGlobal Signal. We think this
type of think-ing by competitors plays into AmericanTowers
hands.
Are there key technology risks here?
CA: Clearly, if some way is developed thatallows the wireless
exchange of voice anddata without the use of ground antennae,that
would be a disruptive event. From
Value Investor Insight 15November 30, 2006
I N V E S TO R I N S I G H T : Charles Akre
American Tower(NYSE: AMT)
Business: Owner and operator of morethan 22,000 wireless and
broadcast com-munications towers and rooftop sites in theUnited
States, Mexico and Brazil.
Share Information(@ 11/29/06):
Price 38.2352-Week Range 26.35 38.74Dividend Yield 0.0%Market
Cap $16.04 billion
Financials (TTM):
Revenue $1.08 billionOperating Profit Margin 10.0%Net Profit
Margin (-9.5%)
THE BOTTOM LINE
High regulatory barriers and booming wireless demand help
protect the 90% incre-mental gross margins the company earns in
leasing available tower capacity, saysChuck Akre. If book value
increases at the 20% annual rate he expects, paying eventhe current
25x multiple of 2007 free cash flow will pay off handsomely, he
says.
I N V E S T M E N T S N A P S H O T
AMT PRICE HISTORY
Sources: Company reports, other publicly available
information
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25
20
15
102004 2005 2006
Valuation Metrics(Current Price vs. TTM):
AMT S&P 500P/E neg 20.4P/CF 43.7 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
T. Rowe Price 8.4%Fidelity Mgmt & Research 7.5%Goldman Sachs
5.7%Wellington Mgmt 5.2%Chieftain Capital 3.7%
Short Interest (@ 11/8/06):
Shares Short/Float 4.9%
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what we can see now, theres nothing likethat on the horizon.
One risk is that another shoe dropswith respect to an
options-backdatinginquiry at the company. Heres a casewhere we have
to make judgments aboutthe people. Having known [CEO] JimTaiclet
and [CFO] Brad Singer for quite afew years, I take it at face value
when theytell me they were not involved in theissuance and pricing
of any backdatedoptions. It will take its course, but I
expectultimately that the biggest downside forshareholders will
turn out to be thattheyve stopped an aggressive stock-buy-back
program until this is sorted out.
How attractive are the shares at a recentprice of just over
$38?
CA: We own a lot of shares with a costbasis of around $10, so
the current priceisnt the deal it has been. It trades atabout 25x
our estimate of 2007 free cashflow, but weve kept a very large
positionbecause theres a high probability thecompany can compound
book value atclose to 20% annually for the next fiveyears. If they
compound at 20% per yearand you have to pay 25x to get that,
thearithmetic still works very much in yourfavor.
By 2010, before theyre in a positionto be paying taxes, I expect
there to be atransforming event for this company.Theyll convert to
a REIT or someonewill buy it for the extraordinary cashflow,
long-term contracts and high-quali-ty tenants.
What attracted you to your next pick,OReilly Automotive
[ORLY]?
CA: We got to know OReilly and theauto-parts business through
owningAutoZone and Advance Auto Parts. As anoperator, we believe
OReilly has the bestmodel, with 50% of its revenues comingfrom
selling parts and supplies to individ-ual do-it-yourselfers and 50%
from com-mercial garages and auto-repair shops.Because of that mix,
the company has ahigher concentration of distribution cen-ters
relative to their stores, giving them
better in-stock positions and same-dayservice capability not
only for the profes-sionals who require that kind of service but
also the DIY market. OReilly serv-ices stores from a distribution
center atleast five times a week, as opposed toother DIY
competitors who can only do itonce or twice a week. That gives them
acompetitive advantage their productsare much more likely to be in
stock ordelivered within 24 hours.
Is such a system much more expensive?
CA: It works well for them their returnson equity are in the
upper-teens.
Is this a growth business?
CA: The market is largely driven by thenumber of cars on the
road and miles driv-en, which continue to grow. It can beaffected
by gas prices or a slowing econo-my in the short term, but the
underlyinggrowth trend is up.
The big opportunity for OReilly is thatauto-parts supply is
still a fragmented busi-ness, with a tremendous number of
mom-and-pops who are willing to sell for netasset value when one of
the bigger chainscomes along. Even a bigger company likeCSK Auto
[CAO], with 1,300 stores in theWest, is considered to be mismanaged
and
Value Investor Insight 16November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Charles Akre
OReilly Automotive(Nasdaq: ORLY)
Business: Domestic marketer of automo-tive aftermarket parts,
tools, supplies andaccessories, targeting both
do-it-yourselfcustomers and professional installers.
Share Information(@ 11/29/06):
Price 31.5552-Week Range 27.49 38.30Dividend Yield 0.0%Market
Cap $3.59 billion
Financials (TTM):
Revenue $2.24 billionOperating Profit Margin 12.6%Net Profit
Margin 7.9%
THE BOTTOM LINE
As the premier operator in a consolidating auto-parts-supply
business, O'Reilly is well-positioned to translate revenue and
margin increases into high-teens annual earningsgrowth, says Chuck
Akre. He believes such growth prospects are not all adequatelybuilt
into the shares, which trade at 15x his estimate of 2007 free cash
flow.
I N V E S T M E N T S N A P S H O T
ORLY PRICE HISTORY
Sources: Company reports, other publicly available
information
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35
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20
15
40
35
30
25
20
152004 2005 2006
Valuation Metrics(Current Price vs. TTM):
ORLY S&P 500P/E 20.5 20.4P/CF 15.0 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
T. Rowe Price 8.5%Select Equity Group 8.2%Wasatch Advisors
6.6%Ruane, Cunniff 3.7%William Blair & Co 3.6%
Short Interest (@ 10/9/06):
Shares Short/Float 5.2%
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would make an attractive acquisitionopportunity for either
OReilly or AdvanceAuto. OReilly actually has the better bal-ance
sheet to do so and I believe theyremuch better, more-focused
operators.
The company is opening 170 newstores this year and has been
growingsquare footage 12-13% per year. If youcombine that with
mid-single-digit growthin same-store sales, growing buying powerand
the prospect of a large acquisition oneday, it's pretty easy to see
how they can getto high-teens annual earnings growth.
At $31.50, how cheap are the shares?
CA: We think theyll earn $1.75 in freecash flow per share this
year and around$2.10 next year. So the shares trade at a15x
multiple, for a company growing bookvalue at least in the high
teens. Again, thatsmath I expect to work out well.
Your last pick, 99 Cents Only Stores[NDN], appears to be more of
a turn-around play.
CA: The company was founded in theearly 1980s and is one of the
four majordollar-store chains in the U.S. Its also, bythe way, one
of only two of those thatactually sells things for only $1 or
less.Many of the stores youd mistake for yourlocal supermarket,
with an astoundingrange of brands. When 99 Cents buys
themerchandise at closeout, the big brandsknow the merchandise wont
get back intothe normal distribution channel.
The news here hasn't been great. Theyentered the Texas market a
few years ago,didnt get it right and have been losingmoney there.
The management transitionbetween the founder, David Gold, and
hisson-in-law, Eric Schiffer, hasn't gone well.They have
underinvested in systems andtechnology, gone through more than
oneCFO and changed auditing firms twice inrecent years, with the
result that theyhaven't filed audited financial reports yetthis
year.
The result of all that has been that thestock went from the
mid-$30s three yearsago to under $10 a year ago. We actuallystarted
our position around $14 and have
bought more on the way down. [NDNshares currently trade around
$11.25.]
Where does a competitive moat comefrom in this business?
CA: Against more traditional retailers, 99Cents Only offers good
value and sometreasure-hunt excitement. Within thedollar-store
market, we think it offers amore attractive product mix, with
fewerknick-knacks and novelty items and morefocus on food. They
also have a particu-larly strong real-estate footprint in south-ern
California and have proven to be moreskilled in finding closeout
merchandise.
Where do you see the clouds lifting?
CA: Despite all the problems, the businessis modestly profitable
and producinggood cash flow. Same-store sales are pos-itive, so
customers are still attracted. Thekey problems are Texas and their
back-end infrastructure, both of which are sta-bilized and showing
signs of progress. Webelieve the people running the businessare
smart retailers and we see no reasonwhy they can't get return on
equity atleast back to the 15% range, which is farless than the
company earned historically.This can be a terrific business if they
exe-cute well.
Value Investor Insight 17November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Charles Akre
99 Cents Only Stores(NYSE: NDN)
Business: Retailer of primarily name-brandfood and general
merchandise priced under$1, with nearly 240 stores in
California,Texas, Arizona and Nevada.
Share Information(@ 11/29/06):
Price 11.2352-Week Range 9.47 13.88Dividend Yield 0.0%Market Cap
$781.3 million
Financials (TTM):
Revenue n/aOperating Profit Margin n/aNet Profit Margin n/a
THE BOTTOM LINE
The company is poised for a turnaround after a series of
operational and administrativeblunders in recent years, says Chuck
Akre. By better managing its balance sheet andachieving even 50% of
prior operating margins, it can earn $1.50 per share makingthe
current $11.25 share price appear extremely cheap, he says.
I N V E S T M E N T S N A P S H O T
NDN PRICE HISTORY
Sources: Company reports, other publicly available
information
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25
20
15
10
5
30
25
20
15
10
52004 2005 2006
Valuation Metrics(Current Price vs. TTM):
NDN S&P 500P/E n/a 20.4P/CF n/a 14.4
Largest Institutional Owners(@9/30/06):
Company % Owned
Akre Capital 9.9%Primecap Mgmt 6.8%Dimensional Fund Adv
5.5%Friedman, Billings, Ramsey 4.9%Amvescap 4.7%
Short Interest (@ 10/9/06):
Shares Short/Float 12.2%
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How are you thinking about valuation?
CA: Hard book value is $7 per share,including a couple dollars
of cash. Realestate values above stated book value they own 35
stores and two distributioncenters add another $2-4 per share. Soat
a share price just over $11, we've got abook value that's 80-100%
of marketvalue. On the upside, if they use their bal-ance sheet
prudently and achieve even50% of prior operating margins, we cansee
them earning $1.50 per share. At thatlevel of earnings, we'll make
a lot ofmoney from the current price.
How patient do you expect to have to be?
CA: Weve heard from a handful of pri-vate-equity types because
of the size of ourstake, which is around 10%. Ive saidwere willing
to give management a chancefirst. If they can't get it right,
there's likelyto be some sort of catalyst to get it right.
In general, how do you approach thedecision to sell?
CA: Valuation rarely comes into play inour sell decisions. We
sell when somethingmaterially changes among the three thingswe
focus on, the business model, the peo-ple or the reinvestment
opportunities.
We recently sold Citigroup, for exam-ple, which originally came
from a bigstake we bought in Salomon Brothersafter its
Treasury-bond scandal. [FormerChairman] Sandy Weill demanded a
25%ROE from every business unit and if themanagement didnt produce,
they werehistory. On one hand, that type of thing ismusic to my
ears, but the other side of itwas that it didnt exactly matter to
Weillhow you made your numbers. We sold,then, for a couple of
reasons. First, thedriver at the top demanding high rates ofreturn
from individual businesses wasgone. Second, the unwinding of all
thepast bad behavior made it difficult for usto judge with
confidence how attractivethe returns would be going forward.
Another example is Willis Group[WSH], the insurance broker. We
had theidea after 9/11 that the insurance-broker-
age business would benefit from changesin insurance pricing and
we thought Willishad an opportunity to take share fromcompetitors
like Marsh & McLennan,which were much more tarnished in
theprice-rigging scandal. This was a casewhere the upside just
didnt ever arrive, soafter a couple years we just gave up.
CarMax [KMX] would be an exampleof something we expect to own
for a verylong time, even though we wouldnt buymore at the current
valuation. We love thebusiness model, the people and the
rein-vestment opportunities. Its sold almostthe entire time weve
owned it for north of
20x free cash flow per share, but if theyachieve their ten-year
objective of growing15% per year which we believe they can well do
extremely well from here.
Have you held your Berkshire Hathaway?
CA: Yes, even though its return character-istics are now lower
than what were typ-ically looking for. I see it as sort of a
low-teens compounder of book value with ahuge option the $40-plus
billion of cashthat could allow them to make extraordi-nary
purchases in an adverse time.
You mentioned the potential of activismwith 99 Cents Only. How
much of anactivist do you tend to be?
CA: We want to have a regular and in-depth dialogue with
management. Iveowned shares in International Speedway[ISCA] for
nearly 20 years. Its an amazingbusiness model: the barriers to
entry arehigh and they not only get ticket and con-cession sales
from the motorsport venuesthey own, but they get the biggest
portionof TV and radio revenues. For years it has
been a business with little debt and ROEsfrom the low-teens up
to 25%. But myfeeling is that theyre now not takingadvantage of the
quality of the businessand have been willing to accept
too-lowreturns. We've had several chats withthem around this
issue.
Are you active on the short side?
CA: If I'm successful investing in business-es which compound
economic value pershare at a 20% rate, then our expectedannual
returns are likely to be around20%, less the costs of achieving it.
For 13years, the hedge fund has averaged around21%, net of all fees
and incentives. Theincremental returns come from what wedo around
the edges, as I call it.Sometimes it's from shorting, or making
ashort-term trade or participating in anarbitrage opportunity.
With shorts, we take a lot of little bites,rather than
concentrate. Were looking forbad business models, bad accounting,
badpeople or bad valuations. Our short bookregularly adds to
overall performance,sometimes only a little and sometimesmuch more.
In 2002, it was the reason wewere up in a terrible market our
shortreturns were 9% and our net returns, afterincentives, were
4.5%.
The market turning south was when youseem to have really hit
your stride.
CA: At the end of 2000, the FBR mutualfund I manage was four
years old and had$9 million in assets. We had a fine, butnot
spectacular record. We then had pos-itive results across all our
businesses dur-ing the 2000-2002 period, a time whenthe S&P 500
was down nearly 40% andNasdaq off nearly 70%. This may be themost
significant achievement of my invest-ing career. When we then also
had home-run years in 2003 and 2004, we reallystarted to get
noticed.
What I particularly enjoy is when youcan help change the choices
people havein their lives. I put my sister into sharesof Berkshire
at $200 per share and shestill has them. Thats the coolest
experi-ence of all. VII
Value Investor Insight 18November 30, 2006
www.valueinvestorinsight.com
I N V E S TO R I N S I G H T : Charles Akre
ON BERKSHIRE HATHAWAY:
Its a low-teens compounder of
book value with a huge option
$40-plus billion of cash to
make extraordinary purchases.
-
Six and a half years ago, at whatturned out to be the very peak
of theInternet bubble, famed hedge-fund man-ager Julian Robertson
closed his fundwith the following prophetic words:
This is an irrational market, whereearnings and price
considerations takea back seat to mouse clicks andmomentum. The
current technology,Internet and telecom craze, fueled bythe
performance desires of investors,money managers and even
financialbuyers, is unwittingly creating a Ponzipyramid scheme
destined for collapse.There is no point in subjecting ourinvestors
to risk in a market which Ifrankly do not understand.
A week later, I wrote a column askingwhether Warren Buffett
should also call itquits the parallels with Robertson weremany but
answered with an emphaticno because Buffett had not fallen into
thetrap of buying companies trading at lowmultiples but with poor
financials andweak future prospects. My argumentwas that Robertson
appeared to have fall-en into the trap of buying companies
ofincreasingly lower quality in order to con-tinue paying the
prices to which he hadbecome accustomed.
To support my argument, I presentedthe table reproduced on this
page, con-trasting the major U.S. public stock hold-ings of
Buffetts Berkshire Hathaway andRobertsons Tiger Management.
Everyone of Buffett's picks were characterizedby solid growth, high
margins, great bal-ance sheets, and returns on equity thatexceeded
their cost of capital. WhileTigers holdings were ostensibly
muchcheaper, they also had lots of debt, lowmargins, poor returns
on equity anderratic growth. My conclusion at thetime: This is a
lame collection of compa-nies which deserves to trade at a
lowaverage multiple!
As I prepared to interview Robertsonrecently (see page 21), I
was curious to