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T2 P ARTNERS LLC
Whitney R. Tilson and Glenn H. Tongue phone: 212 386 7160Managing Partners fax: 240 368 0299
www.T2PartnersLLC.com
January 8, 2009
Dear Partner,
We hope you had wonderful holidays and wish you a happy New Year!
In each of our annual letters we seek to frankly assess our performance, reiterate our core investment philosophy and share our latest thinking about various matters. In addition, we disclose and discuss our 10 largest positions in the hopes that you will share the confidence we have in our funds future
prospects, which in our opinion have never been brighter.
Our fund had a poor December, capping a dreadful quarter and a disappointing year:
December 4th Quarter Full Year
TotalSince
Inception
AnnualizedSince
InceptionT2 Accredited Fund - gross -4.0% -24.1% -18.1% 128.5% 8.6%T2 Accredited Fund - net -4.0% -23.0% -18.1% 88.3% 6.5%S&P 500 1.1% -22.0% -37.0% -13.1% -1.4%Wilshire 4500 3.5% -27.9% -39.8% -3.0% -0.3%Dow -0.4% -18.4% -31.9% 18.4% 1.7%
NASDAQ 2.7% -24.4% -40.0% -26.9% -3.1%
This chart shows our performance since inception:
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150
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
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Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
(%)
T2 Accredited Fund S&P 500
Past performance is not indicative of future results. Please refer to the disclosure section at the end of this letter. The T2 Accredited Fund was launched on1/1/99. Its returns are after all fees. Gains and losses among private placements are only reflected in the returns since inception.
145 E. 57th Street, 10 th Floor, New York, NY 10022
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Performance ObjectivesIn every year-end letter we repeat our performance objectives, which have been the same since our funds inception: Our primary goal is to earn you a compound annual return of at least 15%, measuredover a minimum of a 3-5 year horizon.
We arrived at that objective by assuming the overall stock market is likely to compound at 5-10%annually over the foreseeable future, and then adding 5-10 percentage points for the value we seek toadd, which reflects our secondary objective of beating the S&P 500 by 5-10 percentage points annuallyover shorter time periods. While a 15% compounded annual return might not sound very exciting, itwould quadruple your investment over the next 10 years, while 7-8% annually about what we expectfrom the overall market would only double your money.
Since inception 10 years ago, we have not met our 15% objective, thanks in part to a weak market, buthave outperformed the S&P 500 by 7.9 percentage points per year, within our 5-10 percentage pointgoal. There are few funds that have beaten the market by this margin over the past decade, but we are
not satisfied with our performance and aim to improve upon it.
Performance AssessmentHad you told us last January that our prediction of much pain and suffering in the housing sector, whichwould have a devastating impact the nations financial institutions, would be proven absolutely correct,and that the resulting gains in our short book would be a major contributor to our fund outperforming theS&P 500 by nearly 20 percentage points (our second-best year ever relative to the markets), we wouldhave eagerly looked forward to a good year. But it wasnt a good year, especially the last quarter.
It is particularly galling to us because we correctly identified the housing bubble and anticipated its bursting, so we avoided nearly all investments in the real estate and financial sectors. Our mistake, as
we discuss in detail below, is that we failed to see how widespread the damage would be. We thoughtthe bursting of the bubble would create a significant economic headwind, to be sure, but not cause thenear-Armageddon fallout that instead occurred, so we left the portfolio exposed to many retail andconsumer-related stocks, which have been crushed.
We take pride in our work, have our reputations and financial well being at stake, and are accustomed toconsistently beating the market and making money, so the past year was disappointing.
That said, weve gone through rough patches before and have always rebounded strongly. Because wemanage a concentrated portfolio, over short periods of time and we consider one quarter a very brief
period in light of our typical 3-5 year investment horizon our results can be volatile, so we want to be
careful not to overreact. Frustration and its companion, impatience, are the enemies of successful valueinvesting.
We are determined to improve our performance, but will not change our core investment philosophy andapproach. Rather, we will work even harder to expand our circle of competence, learn from our experiences both positive and negative and patiently seek out the best opportunities.
Were pleased to report that thanks to the unprecedented volatility and carnage in the markets, werefinding many wonderful investments that we think are deeply undervalued and poised to provide futureoutperformance. We have the highest degree of conviction in our current portfolio that weve ever hadand hope that this letter in particular, the discussion of our 10 largest positions helps you share our
conviction.
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An article in The Wall Street Journal last week about the travails of many hedge funds had a paragraphthat summarized the opportunity we believe exists:
Alls not lost for hedge funds, however. Survivors of 2008s market tsunami likely will enjoy lucrativeopportunities amid much less competition. As many as half the hedge funds that began 2008 could close,or be short of cash, as the new year unrolls. Those with cash on hand and a stable investor base will beable to take advantage of bargains in stocks and various debt markets.
Overview of 2008It was an extraordinary year so much so that we suspect we will tell our grandchildren about survivingthe Great Bear Market of 2008. In our 2002 annual letter , we wrote that there were few places to hideas the bear market extended to stocks of nearly every type and this was even more true last year.Fortunately, however, weve added shorting to our toolkit since then and, as we discuss below, it madequite a difference.
In 2008, the Nasdaq had its worst year since its inception in 1971 while the Dow and S&P had their worst years since the 1930s. The S&P had its 3 rd worst year ever going back to 1825, as the chart inAppendix A shows. In total, an estimated $7 trillion of U.S. stockholder wealth evaporated in 2008.
Even more remarkably, the U.S. was one of the best performing markets in the world, as the averagedeveloped country market (excluding the U.S.) fell 45%, while emerging markets plunged an average of 55%. Japan had its worst year ever, down 42%, while the popular BRIC markets (Brazil, Russia, Indiaand China) tumbled 41%, 67%, 52% and 65%, respectively. Worldwide stock market losses wereapproximately $30 trillion. The average long-short hedge fund was down 26% through November.
Market volatility was unprecedented. After Lehman Brothers sank into bankruptcy in September, theS&P 500 had moves of at least 5% on 18 days, more than the 17 such days in the previous 53 years .
To shed light on how the market turbulence impacted our portfolio in 2008, wed like to focus on threestories that summarize the year: a home run, a costly error and a question mark.
A Home RunAs noted above, we correctly identified the housing bubble and anticipated its bursting, so we avoidednearly all long investments in the real estate and financial sectors and aggressively shorted stocks inthese sectors and beyond. In total, we profitably shorted a wide range of stocks during the year, 23 of which contributed more than 50 basis points of performance during the year vs. only one that cost usmore than 36 basis points (Usana, 59 bps). Thank goodness we did so or 2008 would have been a totaldebacle.
As discussed on the next page, we profitably shorted stocks in a wide range of sectors, but the singlegreatest concentration was in the financial sector, where we had profitable shorts among the bondinsurers (Ambac and MBIA), GSEs (Fannie Mae, Farmer Mac and Freddie Mac), investment banks(Bear Stearns and Lehman Brothers), large banks (Bank of America, Wachovia and WashingtonMutual), regional banks (Regions Financial and Zions Bancorp), REITs (Boston Properties, GeneralGrowth, Macerich and Simon Properties), mortgage insurers (MGIC, PMI and Radian), as well as AIG,Allied Capital, Capital One Financial and Moodys.
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It is safe to say that we will never have a year like 2008 again on the short side, but we believe we cancontinue to both hedge our portfolio and generate positive returns through selective shorting goingforward.
A Costly ErrorIn last years annual letter , were embarrassed to admit that we wrote the following:
The primary reason for our funds recent underperformance is its exposure to the retail sector, which in2007 was the second-worst-performing sector in the market after financials. We didnt decide to make asector bet on retail rather, we own each stock on its own merits yet one might reasonably ask, Dontyou guys read the papers? Dont you know that the U.S. consumer is getting hurt by the bursting of thehousing bubble, the credit crunch, higher gas prices, etc.?
Our answer: of course were aware of this and the possibility that things could get even worse, but:
A) While we wish we had the ability to predict macro factors, we dont, so when we find a cheapstock that we think has low risk of permanent loss of capital as well as strong upside
potential, we usually dont let worries about macro factors deter us from buying it. We focuson analyzing and understanding micro factors such as a companys margins and futuregrowth prospects, industry competitive dynamics, etc. rather than trying to predict when thehousing bubble will finish deflating, the direction of interest rates, oil prices, the overalleconomy, etc.
B) The American economy and consumer have proven to be remarkably resilient and our experience and numerous studies show that when experts are unanimous in their opinion onsome macro factor, theyre wrong more often than not.
C) Finally, we think a great deal of negativity about the U.S. economy and consumer spending isalready built into the prices of the stocks we own.
In hindsight, which is always 20/20, we were too early but we believe we will ultimately be provencorrect and earn large gains in these investments.
It turns out that: A) We should have paid more attention to our macro views; B) The American economyand consumer were not resilient and the consensus opinion was correct; and C) A whole lot more well-deserved negativity about the U.S. economy and consumer spending got built into the prices of thestocks we owned. 2008 was a good reminder that to be a successful value investor, its not enough to bea contrarian. Yes, you must have what Michael Steinhardt calls a variant perception, but you also
have to be right ! We have learned our lesson and have trimmed many of our retail positions.
In our defense, we partially hedged our long exposure in the retail/consumer sector by profitablyshorting numerous richly valued stocks such as Amazon.com, Americas Car-Mart, Apple, Best Buy,Blyth, Conns, Crocs, Gamestop, Garmin, Hanesbrands, Heelys, Herbalife, Lululemon Athletica, MarthaStewart Living Omnimedia, Monster Worldwide, Nutrisystem, Omniture, OptionsExpress, Planar, Rent-A-Center, Research in Motion, Ricks Cabaret, Ryder, St. Joe, Under Armour, Urban Outfitters andVistaPrint. In addition, our highly successful REIT shorts noted on the previous page were in part tohedge our exposure to Target and Sears. Unfortunately, however, our retail/consumer short book wasmuch smaller than our long one.
In summary, last year we could plausibly argue that we were early, not wrong. We can no longer do so.
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We failed to anticipate the fallout from the bursting of The Great Mortgage Bubble, which was a veryexpensive mistake.
A Question Mark
This chart shows our performance during 2008 relative to the three major indices:
As you can see, we had a spectacular month in September and by the end of the month were up on theyear, but then proceeded to track the market during a terrible fourth quarter. What happened? In short,two things: 1) in general, we were too early in trimming our shorts and adding to our long book; and 2)we focused our buying on deeply out-of-favor stocks that we thought had been beaten down to anexcessive degree due to irrational forced selling and the distress got much worse.
The reason we call this a question mark rather than a mistake is that its not yet clear whether we were
early or wrong. In any case, theres no doubt that we were too early. In our October letter , we wrote:With stocks down so much, we have made the conscious decision to be more long and less short, as we seemuch more upside in the stocks we own and less downside in the stocks were short.
The last point is the most important one, rooted in one of our favorite Buffett quotes: be fearful whenothers are greedy and greedy when others are fearful. In our investment careers, other investors had never
been more fearful as they were in mid-October and we had never felt so enthusiastic. Even today,everywhere we look we are seeing some of the most extraordinary opportunities weve ever seen. Berkshireand Fairfax are among the least undervalued stocks in our portfolio, in our opinion which is OK, becausewe believe that in addition to decent appreciation potential, they provide protection against a further marketmeltdown.
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We cannot say when this panic will subside, how much worse things will get or how quickly stocks mightrebound, but we are prepared for the worst and have never felt greater certainty that we will be well rewarded
by the stocks we own at current prices if we remain calm and patient.
With the benefit of hindsight (which is always 20/20), we were at least a couple of months too early intrimming our short positions and investing in the long opportunities we identified. The economicdownturn worsened and this, combined with deleveraging, redemptions, year-end tax selling andwidespread investor panic, led many cheap stocks to become much, much cheaper.
Our portfolio was not immune and we suffered awful Q4 losses among many of our long positions, themost painful of which were Borders (-93.9%), Crosstex (-84.4%), Huntsman (-72.7%), ResourceAmerica (-57.9%) and EchoStar (-38.3%). All except Borders and Resource America are among our top10 positions and are therefore discussed in Appendix B.
As for Borders, a perfect storm of a terrible macro environment, poor management and too much debt
have led investors to conclude that Borders will likely have to file for bankruptcy, wiping outshareholders. There is a very real chance of this outcome, but if Borders survives its stock could risemany-fold so we continue to hold a small position. We were heartened by the recent news that thecompany has brought in a new CEO with an outstanding track record.
Borders reminds us of a stock we once owned, Dennys, which also had a tiny sliver of market cap ontop of a big pile of debt. Such stocks often go to zero, but if they recover the gains can be remarkable.Dennys, for example, hit a low of 23 cents at the end of 2003 in part due to year-end tax selling. Over the next 19 months, it rose more than 26x as this chart shows:
The Importance of PatienceOur value-oriented investment approach often involves buying out-of-favor stocks. Such stockssometimes fall further after we buy them and, even if they dont, they almost always take some time torecover. Famed investor John Templeton once said, If you find shares that are low in price, they dont
suddenly go up. Our average holding period is five years and Bauposts Seth Klarman once wrote at the
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end of a particular difficult year, Being very early and being wrong look exactly the same 99% of thetime.
In every investment we make, we are essentially betting against the market betting that the herd isfailing to appreciate, in pricing a stock where it is, the strengths of a particular company and the futurecash flows that it will generate. There are two dangers to such bets: we could be wrong or, even if wereultimately proven right, the herd could become even more irrational in the short term. In both cases our funds returns may suffer initially, but theres a huge difference over time if we are correct in assessingthe value of a company. The key is to buy significantly undervalued stocks and then for all of us to havethe intestinal fortitude to see the investments through to fruition. For example, among our 10 largest
positions, discussed below, we are underwater on half of them (Winn-Dixie, Huntsman, Crosstex,dELiA*s and Echostar), but in each case think we will end up making money.
Michael Steinhardt, who made investors about 500 times their money over 30 years, once commented:
The hardest thing over the years has been having the courage to go against the dominant wisdom of thetime, to have a view that is at variance with the present consensus and bet that view. The hard part is thatan investor must measure himself not by his own perceptions of his performance but by the objectivemeasure of the market. The market has its own reality. In an immediate, emotional sense, the market isalways right. So if you take a variant point of view, you will always be bombarded for some period of time by the conventional wisdom as expressed by the market.
2009 Outlook and How Weve Positioned Our FundWe continue to believe that the U.S. economy is in the midst of a severe recession that will be more
painful and long-lasting than economists are forecasting. Specifically, economists are predicting thatU.S. GDP will shrink in the first two quarters of 2009 and then resume growing in the second half. Our instinct is that GDP will decline for the entire year, be roughly flat in 2010 and then begin growing at atepid rate. Only the large scale stimulus package and tax cut that will likely be passed in the next monthor so by the new administration and Congress will stave off a more dire outcome.
If we are correct, then corporate earnings will be very weak and difficult to forecast in 2009. Thus, wehave trimmed many of our long positions that we were valuing based on a multiple of earnings for example, Target and Barnes & Noble because we don't think the earnings will be there anytime soon.Instead, we have focused our portfolio on two kinds of stocks: 1) Ones that we believe are massivelyoversold due to technical factors such as tax-loss selling and redemptions/liquidations (see examplesdiscussed below); and 2) Stocks trading at a discount to cash or liquidation value, such as dELiA*s andEchostar, in which we think well make money almost regardless of what the earnings are.
On the short side, we have trimmed (and, in some case, have entirely covered) many of our most profitable positions, as the stocks have fallen to our target prices. However, we continue to hold anumber of shorts, the 10 largest of which are (in alphabetical order): Capital One Financial, KB Home,Lennar, MBIA, Moodys, Netflix, Retail HOLDRs (RTH), Simon Property Group, VistaPrint and WellsFargo.
The Opportunity in Small-Cap, Out-of-Favor StocksWe think there are particularly compelling opportunities in small-cap stocks in out-of-favor sectors suchas Crosstex, dELiA*s, Huntsman, Resource America and Winn-Dixie. Such stocks are particularlyvulnerable to year-end tax selling and forced selling due to funds delevering, getting hit withredemptions and/or closing their doors. When this happens, fund managers need to sell their holdingsirrespective of value and in the case of small-cap stocks, even a single motivated seller can crash a
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stock 10%, 20% or more. We dont like being in the position of owning stocks being hit with this typeof selling, but we much prefer it to voluntary selling by rational investors. In the former case, as long asone has patience and courage (and, of course, is right about the intrinsic value), we believe stock
performance should improve when the forced selling ends, as it eventually does.
In some cases, were taking advantage of forced selling by buying stocks at distressed prices, but we are being selective because we want to maintain flexibility and liquidity in our portfolio and also dont wantto buy a stock today when theres a motivated seller who will be back in the market tomorrow, likelydriving it lower still. At least year-end tax selling is now behind us.
Small-cap companies exposed to the U.S. economy and consumer are in a severe bear market, far worsethan anything weve ever seen. At current prices, we are delighted to own a number of these stocks four of our top six positions have market caps of less than $1 billion though we certainly regret
purchasing them too early. Its important to note, however, that our investing strategy does not dependon great timing. We think its impossible for anyone to consistently buy stocks at their bottoms and
we know we cant do it. Rather, we focus on being right about the businesses and their intrinsic values.
To this end, we never stop analyzing our positions. In particular, whenever we own a stock that hasdeclined materially, we reassess the investment with an open mind and do one of three things: a) If weconclude that weve made a mistake and a margin of safety no longer exists, well sell; b) If intrinsicvalue has declined, but the stock has declined proportionally, such that theres still a healthy margin of safety, well usually hold; or c) If intrinsic value has remained constant or risen while the stock hasdeclined, meaning the margin of safety is even greater, well typically buy more.
We remain patient and vigilant, enhance our portfolios wherever we can, and believe we are well- positioned for a more favorable environment. Our experience has been that the periods of recovery are
very rewarding.
SummaryWhile we are disappointed by our funds recent performance, overall we feel extraordinarily enthusiasticabout its prospects going forward and continue have most of our own net worths invested in our fundsalongside you. We choose to eat home cooking not only out of habit, not only because we should, andnot only so we can tell you that we do, but because we have a great deal of confidence in our strategyand cant think of a better place to invest our money.
Discussion of Our 10 Largest Long PositionsIn Appendix B we discuss our 10 largest long positions across all three hedge funds we manage, which
are (in descending order of size, as of 12/31/08):
1) Berkshire Hathaway2) Wendys3) Winn-Dixie4) Huntsman5) Crosstex6) dELiA*s7) Wal-Mart8) Fairfax Financial/Odyssey Re9) EchoStar
10) Distressed debt position (RMBS tranche)
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ConclusionWe want to acknowledge and thank Damien Smith, who has been an outstanding analyst for us for nearly six years, and Kelli Alires, who does a fabulous job as office manager.
We are also delighted to let you know that Chris Woolford has joined us as an analyst (making us, wesuspect, the only investment fund in the world that has increased its head count by 25% this year!).Weve known Chris for many years and he is an exceptionally high-grade person and analyst. His bio isattached in Appendix H.
We say this at the end of every letter, but we genuinely mean it when we thank you for your continuedconfidence in us and the fund, especially during times like these. Most of our personal assets areinvested in the funds we manage, along with substantial investments from many close friends and familymembers, so we are in this together and are fully committed to generating superior long-term returns for all of us.
As always, we welcome your comments so please dont hesitate to call us at (212) 386-7160.
Sincerely yours,
Whitney Tilson and Glenn Tongue
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Appendix A: Distribution of S&P 500 Returns Since 1825
Source: Value Square Asset Management, Yale University
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Appendix B: 10 Largest Positions
Note: The stocks are listed in descending order of size, cumulatively across all three hedge funds we
manage, as of 12/31/08.1) Berkshire HathawayIn every investment, we look for securities that we believe are safe, rapidly growing and cheap andBerkshire has all three in spades. It has one of the few AAA credit ratings in the world, is flush with ahuge cash hoard (despite making approximately $50 billion of commitments in 2008), is one of thefastest growing large companies in America (earnings of Berkshires operating businesses grew at a23.5% compounded rate from 1993-2007), and we estimate that it trades at approximately a 30%discount to intrinsic value. In addition, it has exemplary corporate governance and is overseen byWarren Buffett, perhaps the worlds greatest capital allocator. In Appendix C is our latest slide
presentation on Berkshire.
Berkshires stock was down 31.8% in 2008, but our losses were quite a bit lower because we took advantage of a brief window of absolute madness in the market. In November, Berkshires shares fellnearly 40 per cent in two weeks to an intraday low of $74,100 and its credit default swap spreadswidened to junk levels based primarily on absurd rumors the company faced huge losses and possibly aliquidity squeeze.
On November 20 th, the very day the stock bottomed (closing at $77,500), we published an article (seeAppendix D) rebutting the nonsense in the marketplace. We also doubled our position and benefittedgreatly as the stock rallied 25% by the end of the year.
Theres no question that Berkshire has been impacted by the deteriorating macro environment. As youcan see in our slide presentation, we have trimmed our estimate of intrinsic value from $157,000 to$136,000, and we estimate that Berkshires book value declined by 10% in 2008, its steepest declineever, as the table below shows. Note, however, that a 10% decline during a year in which the S&P 500declined 37% is actually quite remarkable and is, in fact, the 2 nd best relative performance in the past 27years:
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One might look at the carnage in the market and conclude that, while Berkshire might be cheap, thereare many far cheaper stocks. We agree. Berkshire is probably the least cheap stock in our portfolio, butwe own it because its so safe. Most of the rest of our portfolio is in extraordinarily beaten-down stocksor special situations, many of which are discussed below.
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2) WendysFollowing its recent merger with Triarc Companies, Wendys is now being run by Nelson Peltz and histeam, top operators and capital allocators who engineered a remarkable turnaround at Arbys asignificantly inferior business to Wendys and are a good bet, we believe, to do the same withWendys.
We know Wendys well and have owned the stock in the past. The investment thesis is simple: thecompany has too many company-operated stores, which are performing very poorly, and the companyhas a bloated cost structure. Thus, the game plan is to cut costs and refranchise company-ownedrestaurants exactly what Peltz and his team did so successfully at Arbys.
Wendys market cap is $2.2 billion and it has approximately $1 billion in debt (with covenants andmaturities that we are not concerned about), so thats $3.2 billion of enterprise value. We estimate thatthe combined company will have EBITDA of about $600 million, so today the stock being valued atabout 5.3x EBITDA. We think its worth closer to 8x.
Another way to look at Wendys valuation is to separate the high-margin franchise fee stream from bothWendys and Arbys from the low-margin restaurant operating business. We think the franchise feestream by itself is worth the enterprise value of the company, so youre getting all of the restaurants for free.
Peltz, who is the largest shareholder of the company, certainly thinks Wendys is undervalued as hes been buying back stock not far below todays price.
3) Winn-DixieWinn-Dixie operates 521 supermarkets, 70% in Florida and the rest in Alabama, Louisiana, Georgia and
Mississippi. Thanks to poor management, run-down stores and fierce competition, the company, whichhad 1,000 stores at the time, filed for bankruptcy in early 2005. Having shed all of its debt andapproximately half of its stores, Winn-Dixie emerged from bankruptcy in late 2006 under the leadershipof Peter Lynch, who for the previous three years had been the President and COO of Albertsons, wherehed been in charge of operations, merchandising and marketing for the companys 2,500 stores. Whilethere, he had led a 200-store asset rationalization and $500 million expense reduction program.
During bankruptcy, Winn-Dixie shed its worst stores and is now investing in the remaining ones (it plans to remodel 75 annually until all of its stores have been remodeled), with good results so far: in themost recently reported quarter, gross margins rose, same-store comps at newly remodeled supermarketswere +11.6% and overall same store sales were +3.0%.
Winn-Dixies stock is remarkably cheap in our view. It has a market capitalization of around $860million, but an enterprise value of $700 million after netting out cash of $162 million (the company hasno debt, though it does have lease-related liabilities). Thats cheap for a company with more than $7.3
billion in revenues and projected EBITDA this year of $110-$125 million, even before factoring thevalue of the companys $550 million net operating loss carryforward from the bankruptcy.
Even if one counts lease liabilities as debt, Winn-Dixies enterprise value is a mere 12% of sales, whichis far below its peers as this chart shows:
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EV/S
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
0.40
Winn-Dixie Pantry SuperValu Kroger Weis Mkts Safeway Ruddick
Winn-Dixie has a much stronger balance sheet than these companies (all but Weis have 6-36x more debtthan cash), but Winn-Dixie trades at a far lower EV/S multiple due to its lower margins, as this chartshows:
EBITDA margin
0%
1%
2%
3%
4%
5%
6%
7%
8%
Winn-Dixie Pantry SuperValu Kroger Weis Mkts Safeway Ruddick
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If we thought Winn-Dixies margins had no room for improvement, then we wouldnt own the stock attodays price. However, we see no reason why, over the next couple of years, as Winn-Dixie continuesto remodel stores and grow sales, its EBITDA margin wont double (at which point, it would still bewell below normal industry levels), which we believe will result in at least a doubling of the stock.
Eventually, we think Winn-Dixie will show sales and income growth to a point where it will be a niceacquisition for a company seeking to expand in the rapidly growing southeast region. There are
probably three natural suitors.
For more on Winn-Dixie, see the excellent presentation by our friend Ken Shubin Stein of Spencer Capital, which we included in the appendix of our November 2007 letter .
4) HuntsmanHuntsman is a chemical company that manufactures a wide range of specialty chemicals such as
polyurethanes and pigments. It is a market leader in nearly all its product categories.
Last year there was a bidding war for the company that was won with a bid of $28 a share by buy-outfirm Apollo, which intended to merge Huntsman into a company it controlled, Hexion SpecialtyChemicals. Then the markets and the financing world changed and Hexion tried to get out of the deal,resulting in Huntsmans stock collapsing and Huntsman suing Hexion, Apollo and its banks to forcethem to consummate the deal.
Last month, Huntsman settled with Apollo, releasing them from consummating the deal, and, in return,Apollo paid Huntsman $750 million in cash and agreed to buy $250 million in 10-year convertible notes
a total of $1 billion in cash, which Huntsman has now received. We viewed this settlement asfavorable for Huntsman, but the stock was cut in half, falling below $3, upon the announcement. We
acquired the majority of our position at this time. We think the stock fell for three reasons:
A) Nobody wants to own a levered chemical company in this environment. We wouldnt either, exceptthat the valuation is so compelling and there are no near-term maturities on the debt. Our researchindicates that demand for Huntsmans products is very weak, but on the plus side, the price of thecompanys input costs (mainly energy) have fallen dramatically, which will help Huntsmans operatingmargin going forward.
B) Many arbs owned the stock, expecting (as we did) that the deal with Apollo would go through, albeitat a lower price than originally agreed upon. When the deal fell through, the arbs who were alreadyhaving an especially brutal year sold indiscriminately. We always knew the deal might not happen
and were comfortable owning the underlying business at the price we paid.
C) Investors appear to be misunderstanding the dynamics of whats happening vis--vis the litigation.The key piece of information the market appears to be missing is that Apollo agreed to fully cooperatein connection with Huntsmans litigation against Credit Suisse and Deutsche Bank, which had
promised to fund the deal and then reneged. The suit, which claims the banks conspired with Apolloand tortiously interfered with Huntsman's prior merger agreement with Basell, as well as with the later merger agreement with Hexion, is going to court in May in Texas not a jurisdiction where deep-
pocketed firms want to have this kind of case tried.
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We think Huntsman has a strong case against the banks, especially now Apollo is co-operating, andcould win a big judgment or force the banks to pay a large amount to settle. Moreover, Apollo is highlyincentivized to be helpful, since it will receive 20% of any award over $500 million.
This is a fascinating situation for investors ready to do the research and comfortable with legalcomplexities. It might sound a little bit off the beaten track for what we generally do, but Glenns
background is M&A, banking and LBOs.
5) Crosstex EnergyCrosstex is a midstream pipeline company structured as a master limited partnership (MLP), so theres ageneral partner (GP) (XTXI) and a limited partner (LP) (XTEX). We own both, weighted toward XTXI.Weve been following the company for years and have gotten to know the management and founders,who we think are among the best in the business. Crosstex was formed by a firm called YorktownPartners, which is one of the most prestigious private equity firms in the energy space.
Like REITs, MLPs are required to pay out their cash flows, after debt service, to their owners. Theinitial cash flow goes to the limited partners and, as cash flows grow, an increasing percentage of thecash flow goes to the general partner. The objective of the LP is to pay big dividends, while the GPseeks to grow the LP, primarily by making acquisitions, thereby increasing the revenue split to the GP(XTXI owns 1/3 of the XTEX units/shares). Over time, an MLP typically raises equity capital andmirrors it with debt capital to make acquisitions, which are accretive because the cost of equity plus thecost of debt is less than the ultimate distributable cash flow, so each acquisition is slightly accretive tothe LP and highly accretive to the GP.
Crosstex gathers natural gas in the two primary shales in the country, the Barnett Shale and theHainesville Shale, and delivers it to the customers. These pipeline companies are primarily toll roads
they get paid based on the volume of gas being delivered but its not quite that simple. Crosstex processes the natural gas at both ends, which introduces some profit variability. More importantly, insome cases Crosstex takes delivery and has to hedge its exposure which, in our experience, is a net lossgame. As a result, Crosstex is levered to natural gas prices, which have collapsed, putting Crosstexsmargins under pressure. This, combined with $1.1 billion of net debt (net of a recent $100 million assetsale), has freaked out investors who fear that Crosstex will lose access to both debt and equity capitalforever, thereby impairing the companys ability to grow and possibly even forcing a large cut in thedividend.
We think the leverage is manageable (there are only very small maturities in the next two years), thecompany can maintain its dividend and that the financing markets will eventually return. Management
is making all of the right moves to deal with a very challenging environment, cutting back on cap ex andexpenses, conserving capital, selling excess assets and moving to a more conservative business plan.
We estimate that Crosstexs run-rate EBITDA is $250 million this year so its levered 4.4x. There is adebt covenant that starts ratcheting down in Q3 09, which has investors worried that Crosstex will needto sell more assets possibly a fire sale prices, given the current environment. In the event thatEBITDA falls to levels that necessitate further asset sales, we think the company will find many buyersfor its strategic assets, which are concentrated in the two most important natural gas shales in thecountry. Also, XTEXs EV/EBITDA is 5.4x, which is far beneath what any rational strategic buyer would pay for assets like this, even in this environment. Assets like this almost never become available.Even in a worst-case scenario in which the company must be sold, we think it would be at a significant
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premium to todays price. But we dont think this scenario will come to pass, as Crosstex is nowherenear a liquidity crisis.
At the beginning of 2008, XTXI was at $37.24 and was still above $30 as late as September, but thenrapidly declined to around $10, at which point we thought it was substantially undervalued (plus it wasyielding around 15%), so we began buying. Within weeks, it collapsed even further and hit a low of $2.07 on December 15 th, at which point, it was yielding 62%! This was very painful, but we re-did our analysis and concluded that the share price decline below $10 was not primarily due to fundamentalfactor but rather technical ones the entire sector was getting crushed due, we believe, to hedge fundliquidations/redemptions and year-end tax selling so we added materially to our position.
The behavior of the stock in the past week is validating our belief that there was a great deal of forcedselling. On no news, the stock was up 51% on the last day of 2008 and has continued to skyrocket so far this year, closing yesterday at $5.45, up 110% in the past five trading days.
Even after the stocks big surge over the past week, XTXI is yielding 23.5% and XTEX is yielding31.0%. These yields imply that investors believe that Crosstex will soon cut or eliminate its dividends,
but both entities made their quarterly dividend distributions in early November, well after the stocks hadgone into freefall. Crosstexs board and management are very rational. If they had any doubts about thesurvival of the company, they would not have made these distributions.
6) dELiA*sdELiA*s operates retail stores aimed at teenage girls and also owns and operates a successful directmarketing business. We own nearly 10% of the company, which we think is one of the safest, cheapeststocks we have seen in quite some time.
We started buying the stock in the second quarter of 2008 at around $2.00 per share, equal to anenterprise value of about $55 million, based on our belief that its breakup value substantially exceeded$4 per share. Our investment thesis began to play out in September, when the company announced thesale of CCS, part of its direct marketing division, for $102 million in cash, or $3.28/share (pre-tax).With the stock at $2.50, we expected it to skyrocket immediately, but instead it fell to a low of $1.65 andclosed the year at $2.20 due to some very motivated sellers and a general collapse in the market,especially for the stocks of small retailers.
When dELiA*s reports Q4 earnings for the November through January period, we expect strong profitsand same-store sales, no debt and approximately $75 million in cash ($2.40/share), thanks to healthycash flow during the quarter and proceeds from the sale of CCS. With the stock currently at $2.25,
were not only getting one of the fastest growing specialty retailers in the country for free, but wereactually being paid to own it!
In light of the current environment, one might ask whether a retailer (especially one selling clothing toteenage girls) is worth much, but dELiA*s is actually doing very well and we are very enthusiastic aboutthe companys future. Same store sales were up 7.6% last quarter and margins are rising thanks in large
part to excellent new management. Weve done a lot of research on them, from the CEO to the CFO tothe head merchant, and are very impressed. They are developing brands that are connecting withdELiA*s target market and running a very tight operating ship.
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Last month, we visited a dELiA*s store, met with management and saw their new line of products.Management believes the company will have solid comps and positive free cash flow in the fourthquarter and we think thats likely right.
If the stock were to trade at one times sales, which would not at all be unusual, it would be at nearly $10a share, plus the cash. That may sound pie-in-the-sky, but using other valuation metrics for rapidlygrowing specialty retailers actually results in materially higher values. So, this is a stock at $2.25 thatcould trade at $12 without making any Herculean assumptions.
This stock reminds us of a similar situation in late 2001 when we owned stock in TheStreet.com(TSCM). In December of that year, it fell to $1 at a time when it had $1.43/share of cash, so it wastrading at the same 30% discount to cash that dELiA*s was only a few weeks ago. The difference is thatdELiA*s is profitable today whereas TheStreet.com in 2001 lost over $1/share and was rapidly burningthrough its cash, so it wasnt clear that the stock was a bargain. Nevertheless, it more than tripled inonly four months (and later hit $16), as this chart shows:
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7) Wal-MartWal-Mart was up 17.9% in 2008 one of only two stocks in the Dow to rise (McDonalds, which wealso own, was up 5.6% while the other 28 stocks all fell by double digits). Not much has changed sincewe wrote about Wal-Mart in last years annual letter (and the letter before that and the letter before that):its a solid, well-managed business with decent growth prospects. Amidst the economic stress of 2008,shoppers flocked to Wal-Marts low prices and earnings grew nearly 10%.
With the stock trading at slightly under 15x 2009 earnings estimates, its only slightly undervalued butwere not inclined to sell our position because of the way we own it: through $50 strike five-year optionswe bought about 3 years ago. The options were written on very attractive terms to us and, with thestock at the strike price (after this mornings earnings warning), we like owning Wal-Mart this way.Also, because the options are custom written, theres a wide bid-ask spread if we were to try to sellthem. Note that most of this position is hedged out through call selling and shorting, but we are contentfor now to hold the rest.
8) Fairfax and Odyssey ReWeve talked and written extensively about Canadian insurer Fairfax Financial (we also own one of itssubsidiaries, Odyssey Re (ORH)) and have included a copy of our latest slides on the company inAppendix E. The stock held up well in 2008, rising 9.5%, while Odyssey Re jumped 41.1%.
Fairfax is a controversial company that has been at the center of a nasty tug-of-war between thecompany and short-sellers. We rarely get involved in such messy situations, but did in this case becausewe believe were getting a diverse collection of high-quality insurance businesses at a discount tointrinsic value, plus a free call option on Fairfax and Odyssey Res credit-default swap (CDS) portfolios.
Fairfaxs three major insurance subsidiaries (one of which is Odyssey Re) are doing well: they grew 19-
22% annually from 2001-2007, their return on equity (ROE) in 2007 ranged from 23%-26%, and their combined ratios fell from 109.4 in 2005 to 95.5 in 2006 to 94.0 in 2007, driving a 32.3% gain inunderwriting profit in 2007.
As for CDSs, Fairfax has been trimming its portfolio and has harvested, in cash, well over $2 billion of gains, earning a roughly 10x profit in less than two years. As of October 24 th, Fairfax continued to own$9.8 billion notional amount of CDSs, valued at $596 million, on numerous financial companiesincluding AIG, Fannie Mae, Freddie Mac, Bank of America, MGIC, PMI Group, Radian, WashingtonMutual, Societe Generale and XL Capital (Odyssey owns a similar portfolio). It would be hard toconstruct better portfolios of companies with exposure to the mortgage and credit crises. We keepthinking the gains from the CDSs are coming to an end, but given the market chaos in November and
December, Fairfax might have realized substantial additional profits since Oct. 24th
.
Both companies reported third quarter earnings on October 30 th and their performance was everythingwe hoped for and more. Fairfax earned over $25 per share during the quarter while Odyssey earnedalmost $2 per share. In addition to strong earnings, both companies reported increased cash, reduceddebt, better than expected underwriting results (even with hurricane Gustav) and further credit-defaultswap gains (both unrealized and monetized).
With Fairfaxs stock around $313, it trades at 1.2x tangible book value. We think its core business isworth 1.3-1.5x book value, so at todays price, the stock does not fully reflect this value, plus weregetting a free call option on Fairfaxs CDS portfolio, which could be worth a great deal more. Fairfax
shares our view that its shares are cheap and is aggressively buying back its stock. Using the same
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valuation metrics, Odyssey Res stock is comparably cheap.
9) EchoStar Corp.At the beginning of 2008, satellite TV company EchoStar Communications split into two: Dish Network (DISH) and EchoStar Corp. (SATS), which is a collection of satellites, set-top box businesses and anumber of investments, cash and marketable securities, all managed by legendary founder CharlesErgen. Our slides on this company are in Appendix F.
Subscribers to the Dish Network install a dish, pay a monthly fee of approximately $30 and receive lotsof television channels. In 2006 there was a strong expectation that Dish Network was going to mergewith one of the telcos so, in preparation for that, EchoStar Corp. was formed and received all of theassets that a telco would not want to buy, thereby making Dish Network a more attractive acquisition.
SATS has the typical spin-off dynamics: its smaller than the original company, had a relativelyunnatural initial shareholder base that sold the stock, and management has tended to sandbag the
expectations for the company so that their options are struck at a low price.
At todays stock price, the company is being valued at its cash and investment securities, meaning aninvestor is paying nothing for the companys businesses, technology and investments. This includeseight satellites (six owned and two leased, with an original cost of $1.6 billion), a high value, hard-to-replace asset.
It also includes a set-top box manufacturing business these are the boxes that Dish Network buys with $1.7 billion in trailing 12-month revenue. In a normal income statement environment, that revenuestream would probably be worth $2-3 billion, but the boxes are sold on a cost-plus basis to DISH, sountil DISH is acquired or SATS starts selling these boxes to other customers, that business is not worth a
lot today but it has a tremendous amount of potential value.
We think SATS will start selling to other customers because it has other technologies to make better boxes. When SATS was a wholly owned subsidiary of Dish Network, no one other than Dish would buy the boxes because Dish was as competitor. Now that SATS is an independent company, we expectit will have eventually have success selling boxes to other companies.
Finally, SATS has some other interesting technologies such as Sling Media.
In summary, we think SATS is hugely undervalued, but there are no natural buyers. As a spin-off, itwas likely heavily owned by hedge funds and, given that the stock was down 54% in 2008, many were
likely dumping it. Theres a big margin of safety since the company can be liquidated for more than itstrading for.
10) Distressed debt (tranche of a subprime RMBS)Given how bearish we are on the unfolding mortgage crisis, you might be surprised to learn that we
purchased part of a tranche of a pool of 2006-vintage subprime mortgages. We havent suddenly become bullish far from it. Rather, the price was so low that, even in an Armageddon scenario, wethink well make cash returns of 50-100% annually in the next two years.
The slides in Appendix G provide the details. Theyre mostly self-explanatory, but here are a fewcomments:
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x The first three slides have background information on the pool, which is a typical bubble-era pool of subprime mortgages (an RMBS residential mortgage-backed security).
x The fourth slide shows where the tranche we purchased (the IIA2) is in the capital structure of the RMBS. Its very senior, junior only to the IIA1 tranche, which is already 78% paid off.
x Slides 5-7 show the catastrophic performance of this pool in the 26 months since inception.49.5% of the loans have already defaulted and 5% of the performing loans are defaulting everymonth!
x The final slide shows our expected return (in the third column) based on certain fixedassumptions and one variable assumption: the severity (i.e., losses taken) of mortgages in the
pool that have already defaulted but where the home has not yet been sold. Note that were notassuming anything gets better due to, for example, a stabilization of home prices or a homeowner relief bill passed by Congress. In fact, we assume things get worse , yet still project an IRR of 50-100% on this investment.
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B e r k s h i r e H a t h a w a y : A H i g h - Q u a l i t y , R a p i d l y
G r o w
i n g
7 0 - C e n
t D o
l l a r
H i s t o r y
B e r
k s h i r e
H a t h a w a y
t o d a y
d o e s n o
t r e s e m
b l e t h e c o m p a n y
t h a t
B u f
f e t t b o u g
h t i n t o
d u r i n g
t h e 1
9 6 0 s
B e r
k s h i r e w a s a
l e a d
i n g
N e w
E n g
l a n d - b a s e d
t e x t
i l e c o m p a n y , w
i t h
i n v e s t m e n
t a p p e a
l a s a c l a s s i c
B e n
G r a
h a m - s
t y l e n e t - n e t
B u f
f e t t t o o k c o n
t r o l o f B e r
k s h i r e
o n M a y
1 0 , 1 9
6 5
A t t h a t t i m e ,
B e r k s h
i r e h a d a m a r
k e t v a l u e o f a
b o u t
$ 1 8 m
i l l i o n a n
d
s h a r e h o l
d e r ' s e q u
i t y o f a b o u
t $ 2 2 m
i l l i o n
A p p e n d i x C : B e r k s h i r e H a t h a w a y
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T h e B e r
k s h i r e
H a t
h a w a y
E m p i r e
T o d a y
S t a k e s
i n P u b
l i c
C o m p a n i e s
W o r t
h $ 1 B +
C o m p a n y
S h a r e s
P r i c e
V a l u e
( $ B )
C o c a - C o l a
2 0 0 . 0 $ 4 4 . 8 9
$ 9 . 0
W e l l s F a r g o
2 9 0 . 4 $ 2 6 . 7 2
$ 7 . 8
P r o c t e r & G a m b l e
1 0 5 . 8 $ 6 1 . 4 1
$ 6 . 5
B u r l i n g t o n N o r t h e r n
6 3 . 8
$ 7 9 . 6 0
$ 5 . 1
C o n o c o P h i l l i p s
8 4 . 0
$ 5 3 . 9 1
$ 4 . 5
K r a f t
1 3 8 . 3 $ 2 7 . 8 1
$ 3 . 8
J o h n s o n & J o h n s o n
6 1 . 8
$ 5 9 . 4 4
$ 3 . 7
A m e r i c a n E x p r e s s
1 5 1 . 6 $ 2 0 . 5 3
$ 3 . 1
U . S . B a n c o r p
7 2 . 9
$ 2 3 . 7 4
$ 1 . 7
W a l - M a r t
1 9 . 9
$ 5 5 . 9 1
$ 1 . 1
M o o d y ' s
4 8 . 0
$ 2 2 . 8 9
$ 1 . 1
N o t e : S t o c k p r i c e s a s o f 1 / 7 / 0 9
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T h e B a s
i c s
S t o c k p r
i c e ( 1
2 / 3 1 / 0 8 ) : $
9 6 , 6
0 0
$ 3
, 2 1 4 f o r B s h a r e s
S h a r e s o u
t s t a n d
i n g :
1 . 5 5 m i l
l i o n
M a r
k e t c a p : $
1 5 0 b i l l i o n
T o t a l a s s e t s (
Q 3 0 8 ) : $
2 8 2 b i l l i o n
T o t a l e q u
i t y ( Q 3 0 8 ) : $
1 2 0 b i l l i o n
( $ 1 1 1 b i l l i o n o f a s o f
t h e e n d
o f O c t o b e r
)
B o o
k v a
l u e p e r s h a r e
( Q 3 0 8 ) : $ 7 7 , 5 1 9
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R e c e n t P e r f o r m a n c e o f K e y B u s i n e s s U n i t s
B y
Y e a r :
2 0 0 4
2 0 0 5
2 0 0 6
2 0 0 7
I n s u r a n c e
G r o u p :
P r e m i u m s E a r n e d
G E I C O
9 7 0 1 , 2 2 1
1 , 3 1 4 1 , 1 1 3
G e n e r a l R e
3
- 3 3 4
5 2 3
5 5 5
B e r k s h i r e R e i n s u r a n c e G r o u p
4 1 7 - 1 , 0 6 9
1 , 6 5 8 1 , 4 2 7
B e r k s h i r e H . P r i m a r y G r o u p
1 6 1
2 3 5
3 4 0
2 7 9
I n v e s t m e n t I n c o m e
2 , 8 2 4 3 , 4 8 0
4 , 3 1 6 4 , 7 5 8
T o t a l I n s u r a n c e
O p e r .
I n c .
4 , 3 7 5 3 , 5 3 3
8 , 1 5 1 8 , 1 3 2
N o n - I n s u r a n c e
B u s
i n e s s e s :
F i n a n c e a n d F i n a n c i a l p r o d u c t s
5 8 4
8 2 2
1 , 1 5 7 1 , 0 0 6
M c L a n e C o m p a n y
2 2 8
2 1 7
2 2 9
2 3 2
S h a w I n d u s t r i e s
4 6 6
4 8 5
5 9 4
4 3 6
M i d A m e r i c a n / U t i l i t i e s / E n e r g y
2 3 7
5 2 3
1 , 4 7 6 1 , 7 7 4
O t h e r b u s i n e s s e s
1 , 7 8 7 1 , 9 2 1
2 , 7 0 3 3 , 2 7 9
T o t a l
N o n - I n s u r . O
p e r .
I n c .
3 , 3 0 2 3 , 9 6 8
6 , 1 5 9 6 , 7 2 7
T o t a l O p e r a
t i n g
I n c o m e
7 , 6 7 7 7 , 5 0 1 1 4
, 3 1 0 1 4
, 8 5 9
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R e c e n t P e r f o r m a n c e o f K e y B u s i n e s s
U n i t s
B y
Q u a r
t e r :
I n s u r a n c e
G r o u p :
Q 1
2 0 0 5
Q 2
2 0 0 5
Q 3
2 0 0 5
Q 4
2 0 0 5
Q 1
2 0 0 6
Q 2
2 0 0 6
Q 3
2 0 0 6
Q 4
2 0 0 6
Q 1
2 0 0 7
Q 2
2 0 0 7
Q 3
2 0 0 7
Q 4
2 0 0 7
Q 1
2 0 0 8
Q 2
2 0 0 8
Q 3
2 0 0 8
P r e m
i u m s
E a r n e
d
G E I C O
3 1 2
3 5 8
2 3 7
3 1 4
3 1 1
2 8 8
4 0 7
3 0 8
2 9 5
3 2 5
3 3 5
1 5 8
1 8 6
2 9 8
2 4 6
G e n e r a l
R e
1 9
4 3
- 3 8 9
- 7
7 1
1 0 6
1 7 7
1 6 9
3 0
2 3 0
1 5 7
1 3 8
4 2
1 0 2
5 4
B e r
k s h i r e
R e i n s u r a n c e
G r o u p
1 4 3
1 4 0 - 1 , 6
3 5
2 8 3
9 4
1 3 7
7 3 5
6 9 2
5 5 3
3 5 6
1 8 3
3 3 5
2 9
7 9
- 1 6 6
B e r
k s h i r e
H . P r i m a r y
G r o u p
1 8
3 7
- 1 0
1 9 0
3 5
4 3
1 0 8
1 5 4
4 9
6 3
7 7
9 0
2 5
8 1
- 8
I n v e s t m e n
t I n c o m e
7 8 7
8 5 1
9 0 0
9 4 2
1 , 0 1 8
1 , 1 0 2
1 , 1 0 3
1 , 0 9 3 1 , 0 7 8
1 , 2 3 6
1 , 2 1 7
1 , 2 2 7
1 , 0 8 9
1 , 2 0 4
1 , 0 7 4
T o t a l
I n s u r a n c e
O p e r .
I n c .
1 , 2 7 9 1
, 4 2 9
- 8 9 7 1 , 7 2 2 1 , 5 2 9
1 , 6 7 6 2 , 5 3 0
2 , 4 1 6 2 , 0 0 5 2 , 2 1 0 1 , 9 6 9 1 , 9 4 8
1 , 3 7 1 1 , 7 6 4 1 , 2 0 0
N o n - I n s u r a n c e
B u s
i n e s s e s :
F i n a n c e a n
d F i n a n c i a l p r o d u c
t s
1 9 9
1 9 9
2 0 7
2 1 7
2 5 1
3 4 3
2 8 2
2 8 1
2 4 2
2 7 7
2 7 3
2 1 4
2 4 1
2 5 4
1 6 3
M a r m o n
2 8
2 6 1
2 4 7
M c L a n e
C o m p a n y
6 9
5 9
5 3
3 6
5 5
5 6
5 0
6 8
5 8
7 2
5 0
5 2
7 3
6 8
6 8
M i d A m e r
i c a n
/ U t i l i t i e s
/ E n e r g y
1 4 1
1 0 0
1 4 1
1 4 1
4 1 8
2 7 8
4 1 6
3 6 4
5 1 3
3 7 2
4 8 1
4 0 8
5 1 6
3 2 9
5 2 6
S h a w
I n d u s t r i e s
8 8
1 3 9
1 4 5
1 1 3
1 5 5
1 6 9
1 3 8
1 3 2
9 1
1 1 1
1 2 5
1 0 9
5 1
8 2
4 9
O t h e r
b u s i n e s s e s
3 6 4
5 1 4
4 8 6
5 5 7
4 3 0
6 7 1
6 8 6
9 1 6
6 3 2
9 0 4
8 9 5
8 4 8
7 2 1
8 7 4
7 4 9
T o t a l
N o n - I n s u r .
O p e r .
I n c .
8 6 1 1
, 0 1 1 1 , 0 3 2 1 , 0 6 4 1 , 3 0 9
1 , 5 1 7
1 , 5 7 2 1 , 7 6 1 1 , 5 3 6 1 , 7 3 6 1 , 8 2 4 1 , 6 3 1
1 , 6 3 0 1 , 8 6 8 1 , 8 0 2
T o t a l
O p e r a t
i n g
I n c o m e
2 , 1 4 0 2
, 4 4 0
1 3 5 2 , 7 8 6 2 , 8 3 8
3 , 1 9 3 4 , 1 0 2 4 , 1 7 7 3 , 5 4 1 3 , 9 4 6 3 , 7 9 3 3 , 5 7 9
3 , 0 0 1 3 , 6 3 2 3 , 0 0 2
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TheEarningsofBerkshiresOperating
Businesses
Have
G r o w n a t a
V e r y
H i g h R a t e
A n d
G r o w
t h i s A c c e l e r a
t i n g
N o t e :
C A G R : 1
9 6 5 - 1 9 7 9
, 1 9 7 9 - 1 9 9 3 , 1 9 9 3 - 2
0 0 7 . E P S i s p r e
t a x a n
d n e
t o f m i n o r
i t y i n t e r e s t s .
P e r - S h a r e
P e r - S h a r e
Y e a r I n v e s t m e n t s
C A G R
P r e - T a x E a r n i n g s
C A G R
1 9 6 5
$ 4
$ 4
1 9 7 9
$ 5 7 7
4 2 . 8 %
$ 1 8
1 1 . 1
%
1 9 9 3
$ 1 3 , 9 6 1
2 5 . 6 %
$ 2 1 2
1 9 . 1
%
2 0 0 7
$ 9 0 , 3 4 3
1 4 . 3 %
$ 4 , 0
9 3
2 3 . 5
%
B e r
k s h i r e
i s b e c o m i n g
l e s s o f a n
i n v e s t m e n
t
c o m p a n y
a n d m o r e o
f a n o p e r a t
i n g
b u s i n e s s .
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G r o w
t h i n E a r n i n g s o f B e r k s h i r e s O p e r a t i n g B u s i n e s s e s H a s S l o w e d
a s B u
f f e t
t H a s
A l l o c a
t e d M o r e
C a p
i t a l
t o I n v e s t m e n
t s i n R e c e n
t Y e a r s
* 5 - y e a r
c o m p o u n
d a n n u a
l
g r o w
t h r a
t e o f
E B I T ( e a r n i n g s
b e f o r e
i n t e r e s
t
a n d t a x e s )
t h r o u g
h Q 3 0 7
.
B e r
k s h i r e
s f i g u r e
i s p r e -
t a x E
P S
e x c l u d
i n g a
l l
i n c o m e
f r o m
i n v e s t m e n t s .
N o t e :
L i s t o f
2 5 l a r g e s
t c o m p a n i e s
( b y
m a r
k e t c a p )
t h a t
t r a d e s o n
U . S .
e x c h a n g e s
S o u r c e :
C a p i t a l I Q
, t h r o u g h
1 / 6 / 0 9
C o m p a n y N a m e
M a r k e t C a p
% G
r o w t
R a t e *
E x x o n M o b i l
$ 4 0 8 , 4
5 8
2 4
W a l - M a r t
$ 2 1 9 , 7
4 1
1 0
P r o c t e r & G a m b l e
$ 1 8 5 , 6
2 1
1 4
M i c r o s o f t
$ 1 8 4 , 6
7 2
1 8
G e n e r a l E l e c t r i c
$ 1 7 7 , 4
0 4
8
A T & T
$ 1 6 6 , 7
7 2
2 6
J o h n s o n & J o h n s o n
$ 1 6 5 , 6
1 4
9
C h e v r o n
$ 1 5 7 , 1
5 9
2 7
B e r k s h i r e H a t h a w a y
$ 1 5 4 , 5
7 3
1 4
P f i z e r
$ 1 2 0 , 0
2 4
6
I B M
$ 1 1 9 , 8
7 7
9
C i s c o S y s t e m s
$ 1 0 4 , 1
6 2
1 3
C o c a - C o l a
$ 1 0 3 , 4
3 9
9
G o o g l e
$ 1 0 2 , 1
8 0
n / a
H e w l e t t - P a c k a r d
$ 9 4 , 9 8 1
2 2
O r a c l e
$ 9 2 , 7 9 9
1 9
V e r i z o n
$ 9 0 , 7 8 2
3
G e n e n t e c h
$ 8 8 , 3 7 1
4 8
P e p s i c o
$ 8 6 , 5 0 9
1 1
I n t e l
$ 8 5 , 4 8 8
1 1
C o n o c o P h i l l i p s
$ 8 3 , 0 0 9
2 8
A p p l e
$ 8 2 , 6 8 9
2 0 2
A b b o t t L a b s
$ 7 9 , 0 0 7
9
M c D o n a l d ' s
$ 6 9 , 2 5 8
1 6
A m g e n
$ 6 1 , 8 1 3
1 4
M e d i a n
1 4
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( 6 )
( 4 )
( 2 ) 0 2 4 6 8 1 0 1 2
1 9 9 6 1 9 9 7 1 9 9 8
1 9 9 9 2 0 0 0
2 0 0 1
2 0 0 2 2 0 0 3
2 0 0 4 2 0 0 5
2 0 0 6 2 0 0 7 Q 1 - 3
0 8
A c q u i s i t
i o n s
N e t
S t o c
k P u r c
h a s e s
B uff ettI sP utti n gB e rk shi r e sM o n e yt oW o rkR a pidl y
A n d
I n c r e a s i n g
l y i n S t o c k P u r c h a s e s
H e s
d o i n g a g o o d
j o b
b u t t h e c a s
h i s c o m
i n g
i n s o
f a s t
!
A h i g h - c
l a s s p r o b
l e m
M a r
k e t s h a v e a w a y o f p r e s e n
t i n g b
i g o p p o r t u n i
t i e s o n s h o r
t n o t
i c e
C u r r e n t c h a o s ,
j u n k
b o n d s
i n 2 0 0 2
B u f
f e t t h a s r e d u c e d a v e r a g e m a
t u r i t y o f
b o n d p o r t f o l
i o s o
h e c a n a c t
q u i c k l y
$ B
W
e e s
t i m a t e
t h a t
B e r k s h
i r e m a d e m o r e
t h a n
$ 5 0 b i l l i o n
i n c o m m
i t m e n
t s i n 2 0 0 8
, o n l y
a f r a c t
i o n o
f w h i c h a p p e a r s o n
t h e c a s h
f l o w s t a t e m e n
t t h r o u g h
Q 3
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A
B r e a k
d o w n o
f B e r
k s h i r e s
C a p
i t a l
C o m
m i t m e n
t s i n 2 0 0 8
I n v e s t m e n
t / C o m m
i t m e n
t
$ ( B )
C o m m e n
t
G e n e r a l
s t o c k p u r c
h a s e s
$ 7 . 4
T h r o u g h
Q 3 ; n e
t o f s a l e s
M a r s /
W r i g
l e y
$ 6 . 5
A u c
t i o n r a
t e s e c u r i t
i e s
$ 6 . 5
Q 2 e v e n
t ; s o
l d m u c
h i n
Q 3
G o l
d m a n
S a c
h s
$ 5 . 0
P l u s
$ 5 B t o e x e r c i s e w a r r a n t s
C o n s t e l
l a t i o n
E n e r g y
$ 4 . 7
M a r m o n
$ 4 . 5
M o r e
t o c o m e
D o w
/ R o h m
& H a a s
$ 3 . 0
G e n e r a l
E l e c t r i c
$ 3 . 0
P l u s
$ 3 B t o e x e r c i s e w a r r a n t s
F e d . H
o m e
L o a n
D i s c .
N o t e s
$ 2 . 4
Q 2 e v e n
t ; s o
l d m u c
h i n
Q 3
C o n s t e l
l a t i o n
P r e
f e r r e d
$ 1 . 0
T u n g a
l o y
$ 1 . 0
I s c a r a c q u
i s i t i o n
S w
i s s
R e u n
i t
$ 0 . 8
P l u s s h a r
i n g a g r e e m e n
t
I N G r e
i n s u r a n c e u n
i t
$ 0 . 4
T O T A L
$ 4 6 . 2
P l u s
$ 8 B t o e x e r c i s e w a r r a n t s
N o t e : D o e s n o
t i n c
l u d e c a p i t a l
c o m m
i t t e d
t o B e r
k s h i r e s n e w
b o n d
i n s u r a n c e
b u s i n e s s , B
e r k s h i r e A s s u r a n c e
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V a l u
i n g
B e r k s h
i r e
O
v e r t
h e y e a r s w e ' v e a t
t e m p t
[ e d ] t o i n c r e a s e o u r m a r
k e t a b
l e i n v e s t m e n
t s i n
w o n
d e r f u
l b u s
i n e s s e s , w
h i l e s i m u l
t a n e o u s
l y t r y i n g
t o b u y s
i m i l a r b u s
i n e s s e s i n
t h e i r
e n t
i r e t y
.
1 9 9 5 A n n u a
l L e t
t e r
I n o u r l a s
t t w o a n n u a l
r e p o r t s , w
e f u r n i s h e d y o u a
t a b l e
t h a t
C h a r l i e a n
d I b e l
i e v e
i s
c e n
t r a l t o e s
t i m a t
i n g B e r
k s h i r e
' s i n t r i n s i c
v a l u e .
I n t h e u p
d a t e d v e r s
i o n o f
t h a t
t a b l e ,
w h i c h
f o l l o w s , w e
t r a c e o u r t w o
k e y c o m p o n e n t s o f v a
l u e . T
h e f i r s t c o
l u m n
l i s t s o u r
p e r - s
h a r e o w n e r s
h i p o f
i n v e s t m e n
t s ( i n c l u d i n g c a s h a n
d e q u i v a
l e n t s ) a n
d t h e s e c o n d
c o l u m n s h o w s o u r p e r - s
h a r e e a r n
i n g s
f r o m
B e r
k s h i r e
' s o p e r a
t i n g
b u s i n e s s e s
b e f o r e
t a x e s a n
d p u r c
h a s e - a c c o u n
t i n g a d
j u s t m e n
t s , b
u t a f
t e r a
l l i n t e r e s t a n
d c o r p o r a
t e
e x p e n s e s .
T h e s e c o n d c o
l u m n e x c l u d e s
a l l d i v i d e n
d s , i
n t e r e s
t a n d c a p i
t a l g a i n s
t h a t
w e r e a l
i z e d
f r o m
t h e i n v e s t m e n
t s p r e s e n t e d
i n t h e
f i r s t c o l u m n .
1 9 9 7 A n n u a
l L e t
t e r
I n
e f f e c t , t
h e c o
l u m n s s h o w w
h a t B e r
k s h i r e w o u
l d l o o k
l i k e w e r e
i t s p
l i t i n t o t w o p a r t s ,
w i t h o n e e n
t i t y
h o l d i n g o u r i n v e s
t m e n
t s a n d
t h e o t
h e r o p e r a
t i n g a l
l o f o u r
b u s i n e s s e s a n
d
b e a r
i n g a l
l c o r p o r a
t e c o s t s .
1 9 9 7 A n n u a
l L e t
t e r
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BuffettsCom
mentsonBerkshiresValuationLead
t o a n
I m p l
i e d M u
l t i p l
i e r o
f A p p r o x
i m a t e l y 1 2
1 9 9 6 A n n u a
l L e t
t e r :
T o d a y ' s p r
i c e / v a l u e r e
l a t i o n s
h i p
i s b o t
h m u c
h d i f f e r e n t f r o m w
h a t
i t w a s a y e a r a g o a n d , a
s C h a r l i e a n
d I s e e
i t , m o r e a p p r o p r
i a t e
.
1 9 9 7 A n n u a
l L e t
t e r :
B e r
k s h i r e
' s i n t r i n s i c v a
l u e g r e w a t n e a r
l y t h e s a m e p a c e
a s b o o k
v a l u e
( b o o
k + 3 4 . 1 % )
1 9 9 8 A n n u a
l L e t
t e r :
T h o u g h
B e r
k s h i r e ' s
i n t r i n s
i c v a
l u e g r e w v e r y s u
b s t a n t i a
l l y i n
1 9 9 8
, t h e g a
i n f e l l w
e l l s h o r t o f
t h e
4 8 . 3 % r e c o r d e d
f o r b o o k v a
l u e .
( A s s u m e
a 1 5 -
2 0 % i n c r e a s e
i n i n t r i n s i c v a
l u e .
)
1 9 9 9 A n n u a
l L e t
t e r :
A r e p u r c
h a s e o f , s a y ,
2 % o f a c o m p a n y ' s s h a r e s a t a 2
5 %
d i s c o u n t
f r o m p e r - s
h a r e
i n t r i n s
i c v a
l u e . . .
W e w
i l l n
o t r e p u r c h a s e s h a r e s u n
l e s s w e
b e l i e v e
B e r
k s h i r e s
t o c k
i s s e
l l i n g w e l l
b e l o w
i n t r i n s
i c v a
l u e , c
o n s e r v a t
i v e l y
c a l c u l a t e d . . .
R e c e n
t l y , w
h e n
t h e
A s h a r e s
f e l l b e l o w
$ 4 5 , 0 0 0
, w e c o n s
i d e r e d m a k
i n g
r e p u r c
h a s e s .
P r e - t a x
E P S
E x c
l u d i n g A
l l Y e a r -
E n d
I n v e s t m e n
t s I n c o m e
F r o m
S t o c
k
I n t r i n s i c
I m p l
i e d
Y e a r
P e r
S h a r e
I n v e s t m e n
t s
P r i c e
V a l u e
M u l
t i p l i e r
1 9 9 6
$ 2 8 , 5 0 0
$ 4 2 1
$ 3 4 , 1 0 0
$ 3 4
, 1 0 0
1 3
1 9 9 7
$ 3 8 , 0 4 3
$ 7 1 8
$ 4 6 , 0 0 0
$ 4 6
, 0 0 0
1 1
1 9 9 8
$ 4 7 , 6 4 7
$ 4 7 4
$ 7 0 , 0 0 0
$ 5 4
, 0 0 0
1 3
1 9 9 9
$ 4 7 , 3 3 9
- $ 4 5 8
$ 5 6 , 1 0 0
$ 6 0
, 0 0 0
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P r e - t a x
E P S
E x c
l u d i n g A
l l
I n t r i n s i c
S u b s e q u e n
t
I n v e s t m e n
t s
I n c o m e
F r o m
V a l u e
Y e a r
S t o c
k
Y e a r E n d
P e r
S h a r e
I n v e s t m e n
t s
P e r
S h a r e
P r i c e
R a n g e
2 0 0 1
$ 4 7 , 4 6 0
- $ 1 , 2 8 9
$ 6 4 , 0 0 0
$ 5 9 , 6 0 0 - $ 7 8 , 5 0 0
2 0 0 2
$ 5 2 , 5 0 7
$ 1 , 4
7 9
$ 7 0 , 0 0 0
$ 6 0 , 6 0 0 - $ 8 4 , 7 0 0
2 0 0 3
$ 6 2 , 2 7 3
$ 2 , 9
1 2
$ 9 7 , 0 0 0
$ 8 1 , 0 0 0 - $ 9 5 , 7 0 0
2 0 0 4
$ 6 6 , 9 6 7
$ 3 , 0
0 3
$ 1 0 3 , 0 0
0
$ 7 8 , 8 0 0 - $ 9 2 , 0 0 0
2 0 0 5
$ 7 4 , 1 2 9
$ 3 , 6
0 0
$ 1 1 7 , 3 0
0
$ 8 5 , 7 0 0 - $ 1 1 4 , 2
0 0
2 0 0 6
$ 8 0 , 6 3 6
$ 5 , 2
0 0 - $ 5 , 4 0 0
$ 1 4 3 , 0
0 0 - $ 1 4 4 , 4 0 0
$ 1 0 7 , 2 0
0 - $ 1 5 1 , 6
5 0
2 0 0 7
$ 9 0 , 3 4 3
$ 5 , 5
0 0 - $ 5 , 7 0 0
$ 1 5 6 , 3
0 0 - $ 1 5 8 , 7 0 0
$ 8 4 , 0 0 0 - $ 1 4 7 , 0
0 0
2 0 0 8
$ 7 6 , 0 0 0
$ 5 , 0
0 0
$ 1 3 6 , 0 0
0
?
A p p l y i n g
t h e 1 2 M u
l t i p l e :
2 0 0 1
2 0 0 8
1 . U n l i k e t h e t a b l e o n p a g e 4 o f t h e 2 0 0 7 A n n u a l R e p o r t , w e i n c l u d e e a r n i n g s f r o m B e r k s h i r e s
i n s u r a n c e b u s i n e s s e s .
2 . A c t u a l r e s u l t w a s $ 6 , 4
9 2 , b u t w e r e d u c e t h i s t o a s s u m e t h e 2 n d - w o r s t y e a r e v e r f o r s u p e r - c a t l o s s e s .
3 . A c t u a l r e s u l t w a s $ 6 , 2
7 0 b u t w e r e d u c e t h e p r e - t a x , p r e - i n v e s t m e n t - i n c o m e m a r g i n s o f t h e i n s u r a n c e
b u s i n e s s e s b y 4 0 0 b a s i s p o i n t s ( f r o m 1 4 % t o 1 0 % ) t o r e f l e c t B u f f e t t s g u i d a n c e i n t h e A n n u a l
R e p o r t .
4 . I n v e s t m e n t s p e r s h a r e w a s $ 8 6 , 0 0 0 a s o f Q 3 , b u t w e e s t i m a t e a $ 1 0 , 0 0 0 / s h a r e i m p a c t d u e t o m a r k e t
d e c l i n e s i n Q 4 .
5 . W e h a v e t r i m m e d o u r e s t i m a t e o f n o r m a l i z e d e a r n i n g s t o r e f l e c t t h e w e a k e c o n o m y .
1
4
3
5
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B e r k s h i r e I s A p p r o x i m a t e l y
3 0 % B e l o w I n t r i n s i c V a l u e ,
N e a r
t h e
M o s t
U n
d e r v a
l u e d
I t s B e e n
i n t h e
P a s
t