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Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.


2011 Value Investing Congress Notes

Day 1:

Speaker #1:

Seeing Value Through the Cloud

Kian Ghazi- Hawkshaw Capital Management

- Background (from Whitney Tilson)

o Kian has been running this company for 10 years
o Worked at Lehman brothers and is a Wharton MBA
o Firm does some of the most extensive scuttlebutt research of anyone in this business
- Understanding how a manger thinks through his ideas is the most valuable part of attending the
o As such, he is going to go really deep into a single idea
- Concentrated value portfolio with a focus on in-depth research
- Long short portfolio
o Extensive primary research: calling customers and former employees to get insights into
the industry
o Trying to confirm or refute their variant view
o They do not use paid networks
o The majority of what they do is cold calls to proprietary contacts who are unpaid
- How do they invest?
o They are value investors but their style goes beyond cheap business—
 Look for high quality, one of a kind business.
 Does the business have a dominant market share, barriers to entry?
 Shown by return on capital (ROC)
 Rock solid balance sheet with excess cash and monetizable assets
o Do a deep dive to try to see land mines before they step on them
o Perform a pre-mortem on an investment
 If there is a permanent impairment to the earnings power, what might cause that?
 If they can think of a lot of these they will avoid investing
o Invest in a business and not a stock

- Best Idea: Ingram Micro Inc. (IM)

o Have talked to 25-30 industry
contacts—employees, customers,
o World’s largest IT distributor—
1500 vendors and 180K value added
o $3B market cap, $35B in sales,
trading .9x TBV and 10x EPS
o Number one share worldwide
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Number 1 in the US and number 2 in Europe

o Bear case:
 Commoditized service in a highly competitive, low margin business
 Mediocre returns on capital and thus the stock should trade at book value
 Shift to the cloud is a major headwind
 If Microsoft, Cisco and HP are trading at 10x earnings, then the middle man
should trade at a lower multiple than those companies
o Subtle industry tailwinds that the market does not understand
 Offers a cost effective sales channel to small to medium sized businesses
 Industry competitive dynamic is shifting toward a better environment
 Cloud fears are overblown
 Oligopoly is developing
o Valuation
 Book value is a floor to the value
 Appraised the business at 100% upside over 2 years
- Why does this opportunity exist?
o Threat of the cloud
 Uncertainty leads to an opportunity
o Large cap tech is out of favor
o Margins are at peak levels
o Change in the industry is subtle
- What is the value of 2 tier distribution
o Exists because they are the primary sales channel for selling tech into SMBs
 8M SMBs
 These firms purchase 40% of all tech products sold
o 30% are sold through 2 tier distribution
 Other 70% is sold direct or through the 1st tier
o Cost effective sales channel
o What is the value to the distributor?
 Cost effective sales channel—outsourced sales
 Don’t need a large sales force—cost effective
 Choose to use this to reach SMB than direct
 Outsourced credit department
o All outside billing and collections
o One credit worthy company
 Outsourced training
 Distributor trains the value added reseller
 Help with troubleshooting
o Industry Quotes
 Comes down to efficiency, logistics and scale—many companies don’t want
to manage sales
o What is the value to the reseller?
 One stop shop: one place and one bill
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 This very important and some customers are willing to pay more for
 Source of financing—need credit extended by the distributor
 Outsourced logistics and fulfillment
 Resellers do not have to hold any inventory—no warehouses
 If an order is placed by 5pm then the product is received the next day
with labeling that says it comes from the reseller
 Support and expertise
 Conferences to help them understand trends
o Realize that price is not everything—service is very important
- Why is a rational oligopoly in the making?
o 4 changes in the industry
 Key geographies have consolidated—less competition
 US: top 5 players have a 75% share
o Top 3 do the same thing
 Mainly sell PCs, printers, and other computer
o Next 2 are slightly different
 High touch, low velocity
 Ship to products directly to the data center
o Servers
 Europe
o Top 5 have 62% share
o #2 and #4 in Germany have merged (# 1 market in Europe)
 Synnex is no longer a price spoiler
 No longer have to build share fast to achieve the scale they need to
 The CEO was the CEO at Ingram
 He is focused on return on tangible capital (ROTC) and profits now
o Margins are trending up
 Lifting the weight off of the shoulders of the industry
o This reduces pricing competition
 Focus on ROC in the entire industry
 Was previously focused on growth
 Didn’t talk about ROC at all
o Synnex is now talking about ROC
o Same is true of Tech Data now
 Company wants to achieve a ROC 500bps above the
cost of capital
o Ingram has a chart dedicated to ROC now
 Targeting ROC 300-400bps above the cost of capital
 Each company is pursuing growth adjacencies with little overlap
 Better growth opportunities and better margins
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Ingram
o Data capture and point of sale—bar code scanners
 Synnex and Tech Data are not in this market
o Logistics
 3rd party logistics
 Have inventory but don’t own it—get a fee
for service
 50% of all items distributed from Wal-
Mart.com come from an Ingram warehouse
o Apple and Amazon as well
 Tech Data
o Mobility
 Synnex
o Outsourcing
 Call centers
 The overlap between the 3 is in the data center market
o Higher margin business
o Really going after other firms’ markets
o These 4 changes can drive mid-teens returns on capital give the changes in the
- Fears of the cloud
o A major headwind to this business in general is customers moving to the cloud
o Cloud computing- distribution of software applications over the internet
 Characteristics
 Shared servers rather than in-house servers
o Servers are in 3rd party data centers
 Virtualization
 Cheaper and broader broadband pipes make the move easier
o Big growth expected
 35% CAGR through 2013
o 2 impacts on the 2 tier distribution
 Software—some companies will shift to the cloud
 Others will leverage two tier distribution
 Hardware
 With the server not on premises anymore, they will not need certain
 There will absolutely be an impact if companies to go to the cloud and
circumvent two tier distribution
 However, just like not all IT services got offshored to India
o Not all software/hardware is going to be going to the cloud:
 Bandwidth constraints
 Mission critical apps
 Service disruptions
 Legal/compliance
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Customized software
o 68% of their sales will not be impacted by the cloud
 Peripherals—monitors, printers
 PCs
o At risk at to competition from the cloud is the remaining 32%
 Mainly software
- Worst case
o 50% shift to the cloud n 5 years
 Very draconian downside scenario
 16% of revenue could go away if half of the 32% exposed goes away
 Lose $1.1B in revenue
 But the other 68% of the business will still grow
 If it can still grow at historical growth levels, that would be $1.2B
o Revenue would be about flat
o Company is priced for an Armageddon scenario
- Base Case
o 30% shift to the cloud in 5 years
 $3.3B headwind over 5 years
 Potential offsets
 Cloud is going to need 2 tier distribution as well
o Value of 2 tier is not eliminated
o Cloud-based service providers will need to be able to tap the
SMB market
 They will not build out their sales forces
 There will be a land grab
 First to market will be important
o The reseller will need 2 tier distribution
 Will aggregate a 1 stop suite for cloud customers
o 50% of lost sales to the cloud could be offset
 Higher end data center products—higher margins
 POS bar codes and scanners
 Base case is 3% growth per year
- Upside case- 10% shift to the cloud (20% is his actual guess)
o 5% growth projected by IDC for non-cloud IT spending
- None of the range of outcomes is horrible
o 0-5% annual growth even if 50% goes to the cloud
- Valuation
o Significant downside protection and 100% upside
o During a 5 month period in 2008 and 2009 the company traded below tangible book
value (TBV)
 Is credit exposure an issue?
 Write offs are 1% of gross profits over time
 Only a small uptick in 2008 and 2009
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Concerns were unfounded

 Is there inventory write down risk?
 80-90% has contractual rights of returns or price protection
o Very little inventory risk
 Gross margins actually improved during the downturn
 Profitable every quarter during the downturn
 $0 inventory write downs
 Managed the downturn really well
o Trading at .9x TBV
 Synnex (SNX): 1.5x TBV
 Tech Data (TECD): 1.3x TBV
o Base case
 3% revenue growth, some reasonable SG&A leverage
 8% EPS growth
 13% return on invested capital (ROIC)
o Apply a 12x forward multiple and add back cash they will
use for a sizable buyback and some tuck-in valuations
 $35 price
 Upside is 90%
o Thinks that ROIC will be better than before and the multiple
could expand to 13-14x
- Risks
o Severe downturn in global IT spending
 But the stock only trades at .9x TBV
o Company is implementing an ERP system for the next 3 years
 There Inevitably will be some hiccups
o HP is a huge customers and losing HP would really hurt
o Ingram straying from its ROIC focus
- Summary
o Had a bias at first and changed his mind after looking at it closer
o Book value sets a floor for the valuation
- Q&A
o How long do they propose to own Ingram?
 3-5 years
 Appraise intrinsic value over a pretty long time frame
 Have a 2 year out price target
o What would inspire the company to sell?
 He likes that it is not a play on one company’s technology
 They are going to take part in the cloud boom
 IM is an arms dealer to all vendors
 What would cause him to sell
 ROIC focus went away
 HP changed how it was going for its distribution
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Not worried about a downturn in tech spending

o Why do the US-based companies in this sector not pay dividends? Why are the
models rated differently outside of the US? Does this make a case for the electronics
manufacturing services (EMS) industry as well?
 Can’t comment on EMS—does not know that sector
 Doesn’t know why Ingram trades at a discount to Synnex and Tech Data
 He does not want to see them pay a dividend
 Thinks they should buy back shares instead
o The best return on allocated capital is from share buybacks
 Not going to get any value from paying a dividend
 Tax inefficient
o How do they narrow down the investing field enough to do so much research on a
single name?
 They used to pass on a company after 2-3 weeks of research
 Implemented screening technology to find a more fertile hunting
 Narrow the universe to the cheapest stocks
 Companies like Ingram Micro had been on his screen for a long time but he
liked a lot the more he dug in
o Did they analyze what TBV consists of?
 Inventory is the biggest chunk
 But, you could not get that carrying value if you were liquidating that
 Price protection and ability to return reduce write down risk but you
can’t liquidate at the value on the balance sheet
 Excess cash
 Net PP&E—world-class distribution facilities
 Accounts receivable
o Question from Whitney Tilson of T2 Partners: Is this like Costco (COST)—high
velocity but low margin business that actually is great?
 Sales are a pass through and gross profits are like true revenue
 Is more like a 25% margin business if you look at it this way
o 22% in 2008 and 2009
o Jumped back to 25% in 2010
 Suggests a better business than it would at first glance
o Is there a franchise value to this business? Brand value?
 Hard to argue for some enduring value for the brand
 Don’t think much about the intangibles in this case
o Thinks about who will miss the company if they it is gone
o Companies only want to deal with 3-5 vendors
 New company would find it hard to enter
 Need customers to attract products and vice
 No good answer to what the price they would not buy more stock back
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 If it were trading a little above TBV he would still buy it

 10% downside and 100% upside is a good tradeoff
o If .8x TBV is the floor
Speaker #2

The Human Side of Investing, or the Difference Between Theory and Practice
Howard Marks- Oaktree Capital Management

- Great quote from Yogi Berra

o ―In theory there is no difference between theory and practice. In practice there is.‖
 This applies to investing
- It is important to realize that there is another side of investing not taught in schools and textbooks
o Professors provide a simple roadmap to investment success
 There is no simple formula and it is the human side that screws it up
o Markets are objective, efficient and clinical and thus assets are priced accurately
 But markets are made up of people who have emotions and swing between
o Riskier assets must provide higher returns to attract capital
 If they could always be expected to produce higher returns then they wouldn’t be
o Appropriate risk premium is incorporated into returns
 Sometimes the premium is appropriate
 Other times it is inadequate or excessive
o Q3 2007 and Q4 2008 were on different extremes
o Since markets price asset fairly, if you buy at the market price you can expect fair returns
 Buying at the market price cannot be counted on to produce a fair return
o People want more of something at a lower price and less as a higher price
 Normal demand curve taught in Economics 101
 Unfortunately, investors warm to investments when they rise and shun them
when they fall
 Demand curve is actually the opposite in investing
- The swing of the pendulum
o Constantly going between greed and fear, risk tolerance and risk aversion, and optimism
and pessimism
o In theory, the pendulum should be at the happy medium
 On average it is in the middle
 But it spends little time there
 Excesses constitute the errors of herd behavior
 3 stages of a bull market
 Few people feel things are getting better
 Most people realize improvement is taking place
 Everyone thinks things will get better forever
 ―What the wise man does in the beginning, the fool does in the end‖
o The last buyer pays the price
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 3 stages of a bear market

 Few people realize that things are overpriced and dangerous
 Most people see the decline is underway
 Everyone believes that things will get worse forever
o Great opportunity to buy if we can behave counter-cyclically
- Importance of being a contrarian
o Quote from Mark Twain:
 ―Whenever you find yourself on the side of the majority, is it time to reform.‖
o A market top is coincident with extreme bullishness
 How do we avoid getting caught up in the mania?
 Approach has to be value-based and objective and we must be steadfast
in our attention to the swings in the pendulum
o What most people believe to be true in the investment world is often not true
 It is very lonely being a contrarian and as value investors we have to be fine
straying from the herd
- Investor memory has to fail us for extremes to be reached
o According to John Kenneth Galbraith one of the main factors that contributes to euphoria
is the extreme brevity of the financial memory
 We are less likely to repeat the past and go to extremes if we can bear these past
events in mind
 1929 repeated in 2008—had to have been born in 1908 to have experienced both
o A man is willing to believe things that will make him rich if they are true
 Greed can overwhelm caution
- Pro-cyclical behavior
o One of the most frequent mistakes investors make
o We were told to buy low and sell high
 Instead we do the opposite
 When the cycle is going well, media is positive, financing is available
o Coincident with rising cycles
o We need to be anti-cyclical when others are acting pro-cyclically
- Overstating knowledge of the future
o Value and growth investors are different
 Value investors focus on the value here and now
 Current assets, current cash, current cash flow
 Growth investors are buying a piece of the dream
o But these are not that different
 We need to understand the future in either case
 At the same time, we should be cautious in what we expect of our prescience
o Another quote from Galbraith: ―There are two kinds of forecasters: those who don’t
know, and those who don’t know they don’t know.‖
o Amos Tversky said that it is frightening to realize that you might not know something
 By in large the world is run by people who have faith that they know exactly
what is going on
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Very dangerous to act as if you know the future

o Quote from Mark Twain
 ―It ain't what you don't know that gets you into trouble. ... It's what you know for
sure that just ain't so.‖
o 2 schools of investing
 The I know school
 The I don’t know school
 The I know school is the most prevalent school
o These people tell others what will happen in the future to
markets and economies
o Tend to invest based on the assumption that they are right
 When they are proven wrong they try to invest again on
their predictions
o Make one outcome bets
o Have concentrated portfolios
o Target only maximum price gains
o Lever heavily
 The best investors are in the I don’t know school when it comes to the macro
o So, what do they do to limit risk?
 Diversify
 No leverage
 Avoid losses
 Is as important as generating gains
 Hedge their bets
o Most people think in terms of norms and ignore outliers
 The I know school thinks in terms of the average
 Never forget about the 6 foot man who drowned in a lake that was 5 feet
deep on average
 These people got into trouble in 2008
 Leverage is what hurt people and didn’t let them survive the outlier
 Single scenario investors cannot account for Black Swans
 Believe that the event they see as most likely is the one that will happen
o There are still many other events that could happen that have a
higher cumulative probability
 Quote from Elroy Dimson
 ―Risk means more things can happen than will happen‖
o It is important to recognize the twin imposters
 Short term outperformance and underperformance
 Neither says anything about skill
 Events collide with an existing portfolio
 Events can be unforeseeable and hurt a thoughtful portfolio
o Doesn’t not say anything about investment ability
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Remember the lessons of Nassim Taleb’s Fooled by Randomness

o Investors are right and wrong for all kinds of reasons
o Good decisions fail all the time; bad decisions work sometimes
o Randomness can produce just about any outcome in the short run
o Alternative histories
 The other things that could have happened
 Events are part of a range of probabilities
 If we understand that then we reduce the
significance of what actually happened
 Long term performance is what we should focus on
o If we think of the past as being as variable as the unknown future, it is very difficult to
get investment timing right
 What should happen and what will happen are very different
 Folly to bet your chips on what should happen
 If you expect too much you get into trouble
o Hard to do the right thing in the investing business
 Impossible to do the right thing at the right time
 We are all going to be wrong
 Being too far ahead is indistinguishable from being wrong
o We must avoid the pitfalls of investment bureaucracy
 David Swenson of the Yale endowment says that ―active management strategies
demand uninstitutional behavior from institutions, creating a paradox that few
can unravel.‖
 Over-diversification
 Fear of embarrassment
 It is better to fail conventionally than to fail unconventionally
 Ultimate conundrum
o We must take the chance of doing a lot of something that fails
o Take the chance of being too early if we are going to be great
o Investing in things with obvious appeal and that can be understood
 Implies elevated prices and substantial risk
 Real bargains come from areas in which the herd shuns
 Focus on buying assets well rather than buying good assets
 Inefficiencies are the superior investor’s reason for being
 Mistakes of others lead smart investors to make vast sums
o Oaktree’s philosophy and approach
 Understanding and controlling risk
 Involved in less efficient markets
 High degree of investment specialization—leads to expertise
 Does not raise and lower cash levels to try to time the market
 No reliance on economic projects
- Q&A
o How much are they holding in cash for future opportunities given the frothy markets?
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Oaktree has lots of different kinds of funds

 Some are 90%+ invested
 Some distressed debt and real estate funds are invested based on their
 In most areas cash is high relative to normal times
o Challenging today to find exceptional bargains
 Risk tolerance is too high
 Time for great selectivity, caution and discipline
o Question from Guy Spier of Aquamarine Funds: Why does Oaktree still run institutional
money if it is so hard and the investors are so biased?
 Swenson has worked it out how to handle institutional investors better than most
of his peers
 He has outperformed his peers by about 3%a year for 25 years
 In Oaktree’s case, some of it is an historic accident
 Howard has been in the institutional business since he was 21
 Believes Oaktree has added value to the institutional world
o Not many people bring this message to the institutional world
o Which area(s) are they finding the most interesting?
 Does not know of any areas in which dollars are going for 50 cents
 Very hard to answer that question
 Oaktree is raising funds which keeps him from marketing outside the
institutional meetings
o Can’t say exactly where but they are raising money in some
o How do you build the right temperament? How has he done it?
 It helps a lot to be born with a reserved and steady temperament
 Aloof, removed, analytical, skeptical
 He didn’t do exercises to develop the right mentality
 Reading is the most important thing
 Read about the excesses of the market
o It should strike a chord with you
o If you read it and it you think it doesn’t apply to you—you are in
the wrong business
 Galbraith book –A Short History of Financial Euphoria
o If you get this book then this business is right for you
 The best investors are not artists
 They are analytical, introspective and not emotional
 Emotional investors may not be able to become value investors
 Need serenity, consistency and stability
 Many forces bear on us- envy, greed, benchmarking, fear
o Forces that cause bubbles, crises, and bear markets
 Value investors see them for what they are and rise to
the occasion rather than succumb
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Hard to teach yourself how to do that

o People who read his new book and don’t get should probably be
in another business
o Question from VIC organizer John Schwartz- Does it help to be well self-analyzed in
order to counteract certain human emotions?
 He once wrote that the most important science is not economics or financial
analyses or accounting
 It is psychology
o People who have their psyches in control are in the best shape to
be great investors
 A portfolio manager came to him in 1998 after LTCM crisis and was
worried that the world was going to end
o Howard said he understood why he was scared but told him to go
back to his desk and manage his portfolio
 A battlefield hero is one who is afraid and does it
 In 2008 they were impressed with the fact that they could be wrong
o Were not sure if they were going to fast or two slow
 It was that tension that told them that they were doing
the right thing
 But it was really hard to do at that time
o Were shown by the fact that very few
people didn’t jump back into the
markets that they were right
o If you couldn’t deploy money back then,
you were not alone
o It is often hard to buy something when prices are falling if you don’t own it. How do they
think about position sizing and how do they scale positions?
 Within the areas they work, they are toward the more diversified end of the
 Have never had a position over 2%
o When things go right, they never have enough
o When you don’t have big positions, you can’t have big mistakes
o Graham and Dodd described fixed income as a negative art
 What you don’t own is what is most important
 Position sizing is forced upon them
 When there aren’t attractive new investments available they may buy
more of things they already own
 Will take large positions of 5-6% in certain distressed situations
 Oaktree I still around after 30+ years because the focus has been on protecting
capital and managing risk
 Many competitors are not around anymore
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o There are old investors and bold investors. But there are not that
many old and bold investors
o Question from Marcelo Lima- If he likes inefficient markets, then why he is Oaktree not
more involved in the equity markets
 They are not active in mainstream equity markets
 But they do have funds for emerging market equities and Japanese
 Just don’t invest in developed world equities
o How does he think about dollar depreciation risk in the long term, especially when it
comes to illiquid investments?
 Clients are looking to Oaktree for dollar-based returns
 Don’t have superior knowledge about dollar depreciation
 So, the best thing to do is try to generate high returns
 Clients are fully equipped to do their own hedging
 Oaktree offers dollar returns and they can hedge if they want
o Question from Ryan Morris of Meson Capital- Does he ever pay attention to external
issues that are not intrinsic to the market but can still affect the market?
 The answer is no
 His son is investing now
 For years the 1st thing Howard says to him when he brings up an
investment idea is who doesn’t already know that?
o Meaning, why is this not priced into the market already?
 For example, trade barriers are likely to go up around the world
 But who doesn’t know that?
 Is that priced in or not?
 He doesn’t know anything about the future or exogenous events that
nobody else knows
o Can’t add value there
 In high yield, the formula is simple:
o Buy ones that will not default and avoid those that will
o Will look at macro factors on individual investments when
assessing the level of risk but does not go beyond that
o He says Oaktree does not raise or lower cash based on market timing but has more cash
now? Is there a contradiction there?
 Likes people to point out his contradictions
 They never say: we are worried about the market and we are adding 10% cash
 What they say is that there is a lot to sell and to little buy so cash levels
float up
o Their actions are the result of active portfolio management
 Not a conscious decision to hold cash
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

Speaker #3

Prospecting for Compounding Machines in a Minefield of Value Traps

Rahul Saraogi- Atyant Capital (from Chennai India)

- Has been investing in India for 11 years

o Long only, concentrated strategy
 No shorting or leverage
 $15M under management
- Ben Graham said that one of the mysteries of the business is how the price of a stock converges
to intrinsic value
o How do we deal with this mystery?
 This is something that value investors are always trying to do
- Munger says, always invert
o So he thinks about what prevents a stock price from converging to intrinsic value
- Background on India
o India has been discovered by value investors
 Some people have had good experiences and others have had bad experiences
o Tailwinds
 Demographics
 1.3B people- 3.5x the size of the US
 600M people under the age of 25
 85% of the people are under the age of 45
 By 2020, 50% of the population will be in urban centers
o This is driving significant demand
 14% nominal GDP growth
o 8% real growth
o This is in spite of the government
 The government has done just about everything wrong
 Demand is growing 25% each year for certain products
 Has very deep markets
o T+2 settlement
o 6000 listed companies
o Every sector is represented
o Cost of going public is low
o Developed investor base
o Founded in 1875—one of the oldest exchanges in the world
 Paradise for value investors
o Very short term and top down focused
 Money waxes and wanes with risk on and risk off trade
 80% of the total market cap of the index is made up of
15 companies
 Market cap weighted indices
o Liquidity advantage
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 People often choose to invest or not invest based on

 ECN based market
 Liquidity is very volatile
 Risk off: $2B market cap company can trade
 Risk on: Same company then trades 2M shares
 Investors refrain from trading in illiquid stocks
 Because they can’t get out in 10 days
 Very happy as value investors to be in these markets
o Information advantage
 Useful universe is top 1500-1700 companies
 $50M to $100B in market cap
o Not much research coverage outside of
the top-tier companies
 If you can put your feet to the ground you can
have a huge advantage
- What prevents a stock from converging to intrinsic value?
o Hurdles
 Eliminate companies that will never converge
 Corporate governance
o Not just fraud and embezzlement
o Many companies have dominant shareholders
 How do they treat minority shareholders?
 Violations
 Not securities fraud necessarily
 Related party transactions
o Buying and selling to companies related
to the dominant shareholders
o Investments/loans to related companies
o Exposed to risks without upside
 Skimming cash from the company
 100% leverage in CAPEX
 How do you identify it?
 Related parties—past track record of
 Fraud/syphoning
o Looking at the financials
 Interest higher than net profits
 Extremely low ROE
 Are they paying taxes?
 Stewardship of capital
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o ExxonMobile (XOM)- has consistently managed to keep ROE

high and returns cash when there are no opportunities
o Can they generate $1 in PV for $1 in retained earnings
o Most companies see declines in ROE because the opportunities
 Are they returning capital to shareholders
o Empire building or vanity?
 Private jets, cricket teams, stadiums?
o Frequent equity dilutions?
o Are they raising money every opportunity they get in a bull
 Business fundamentals
o Domestic demand driven?
o Competition from imports?
o Pricing power?
o Distribution strength?
o Cost competitiveness
o Moats
o Great brands are overpriced in India
 Can’t have an edge in franchise businesses
o Commodity businesses often have moats, but not in a way that
developed market investors usually think of them
 Distribution
 Entrenched position in a market for years
 Financial strength
 Relative opportunity
o Price history
o Major holders
o Insider transactions
o Valuation relative to market
o Valuation relative to industry and peers
 Most people focus on the last 3 aspects
o 2 most important in India are the first 2
o They look for catalysts
 Best catalyst is if the intrinsic value is compounding continuously
 Framework helps them categorize firms as compounding machines
 Not a lot of value in net-nets in India
- Case Studies
o Videocon Industries Ltd. (Bombay Exchange: VEDI.BO)
 Well-recognized brand
 30% compounded growth
 Consumer durables
 Washing machines, dishwashers, and other home appliances
 Can compete with multinational brands
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Understands Indian consumer’s mindset

 Rural Indians have different needs
 Strong financial
 Valuation
 P/B: .74x
 P/E: 7.4x
 Bad corporate
governance and
stewardship of capital
 Relative
valuation is not
 Don’t get caught up in the brand of Videocon
o Just because the business fundamentals look good does not mean
that it is a good company

o Gujarat State Fertilizer and Chemicals (GSFC for short; Bombay Exchange:
 Large producer of complex fertilizers
 Lowest cost producer
 Advantageous port position
 Entrenched distribution
 Debt free
 Most fertilizer
companies have a
lot of debt
 Most of the market
cap is in cash
 State-owned company
 But has great
 Great steward of capital, fundamentals, financial strength and relative valuation
 Looks like a commodity company but it is a great business
 Earnings have tripled from 2007 to 2011
 No earnings smoothing
 Do not care about pleasing the street
 Cash has grown substantially from $48M to $370M (2007-2011)
 Why do they have so much cash?
o Really have a bazooka in a gun fight
 Competitors don’t have the financial strength to compete
o Reinvestment opportunities have been and will be fantastic
 Indian crop yields need to go up
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Complex fertilizers is a growth business in India

 How much can they make?
 Think that earnings can double in 3 years
o If that happens and the P/E ratio re-rates to an 8x, that would
lead the price being 4.4x times higher in 3 years
- Summary
o India has a lot of value traps so you have to be careful what you are invest in
o Sufficient universe of qualifying stocks
 Market is infested but their idea pipeline is full
- Q&A
o How do they know earnings will double at GSFC?
 The markets that the company are in are huge agrarian markets
 Fertilizer growth is faster in their markets than in the rest of the country
 Yields really need to go up so their suite of products will do very well
 Natural growth and cost reductions will lead to a lot of earnings growth
o What is it that allows some companies to fly straighter than other? How are they
insulated from government and business?
 The universe of those companies is very few
 Not even they do it 100% straight
 Lots of low level corruption
 Public servants are not paid well
o Big companies are even involved in paying charges that are not
necessarily legitimate
 Used the example of Hyundai
 See this as a cost of doing business
o Who is corrupt?
 The management – red flag
 The company has to do things on the ground to run their
business—just the law of the land
o What returns are you expecting going forward?
 Returns have been about 10% compounded
 He hopes to be a better investor in 5 years
 The last 5 years has been very interesting in India
 Since 2006 the Sensex has outperformed everything else in India
o The gap between the largest and most visible companies
exploded when hot money flowed into India
 As a result of this money going into the largest
companies, small companies did not outperform the
o How do they measure their alpha? What about India’s returns given inflation and interest
rates? What is his outlook for India?
 Alpha: Manages money with a focus on low downside and high upside
 Opportunities that are growing- growing capital, moats and franchises
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Buy companies when they do not see permanent loss of capital, a margin
of safety and a potential upside greater than 0%
 Inflation and interest rates.- Thinks that rates have overshot on the upside
 Inflation is not driven by rapid growth of money or the general price
 Change in relative prices is happening
o Food prices are going up—Indians are getting wealthy at a
phenomenal rate
 Eating more meat and thus more grains
 Increase in food prices is structural
 Supply infrastructure is exploding due to the price
 A supply boom is 3 years away
 Federal government is using a loose fiscal policy
o Due to democratic set up, reforms have been slow
 Only thing that the bank can do is reign in demand
because supply response is slow
 India will grow 7-8% in the next decade
o 13% nominal growth if there is 5-6% inflation
o Things are good in India and the outlook is good
o Tight money is not a bad thing
 Prevents capital misallocations
 Doesn’t want the Indian banking system to
become insolvent in a few years due to too loose
monetary policy
- Does GSFC export its fertilizer?
o Not, it does not export but they do import some goods

Speaker #4

Using Discipline, Patience and Cash to Realize Long-term Value

Steve Leonard- Pacifica Capital Investments

- Founded his fund in 1998

o 2 phases of his life
 Commercial real estate (CRE) and then public equities
o Moved from LA to Denver and back to Southern California to
take advantage of distressed real estate properties
 Moved along as the recovery became self-sufficient
 Provided substantial returns to investors
 Started his equity fund in 1998 after making money from his real estate
o $250M in AUM now
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

- It’s not about beating the market every time

o Don’t actively trade
o Don’t short
o Don’t use leverage
- Decision making process
o Is the industry/business the type they have a chance of knowing deeply?
 Can/will they know it better than the competition?
 Is it the best company in the industry?
 Does it have global growth opportunities?
 Are there competitive advantages and are the advantages sustainable?
o Does the management generate a high return?
 How do they allocate excess cash?
o Is the price attractive?
 Is there a margin of safety?
 Is there the possibility of strong returns over time?
- 3 mantras
o Discipline
o Patience
o Concentration
 When you find the right company you need to invest heavily
- Often have large cash balances
o Had 50% cash in their accounts in 2007
 2 years later when the market was soft, cash was very low
 Cash levels are building now
o Do best when the market is weakest
 IRR since inception of about 12%
- Focus on the companies they own
o Don’t worry about the macro environment
 Although they do pay attention to unsustainable trends
o Prefer to own American-based companies
 But they want favorable growth opportunities as well
 Developed world policies are not designed for growth
 India, China, Brazil exposure
o Are careful regarding debt levels
 Don’t like companies with large pension obligations
 Entitlements and pension funds are a disaster than will occur down the
- Stocks/holdings
o Fairfax Financial (Toronto Stock Exchange: FFH)
 Is their largest holding
 Really likes the management team
 Thought their experience with CRE helped them understand the P&C insurance
o Berkshire Hathaway (BRK)
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Is their 2nd largest holding

 Allows them to sleep well at night
o Starbuck’s (SBUX)
 When the company was just becoming popular, they saw long lines for expensive
 Could see that the returns they were making on each new store were high
 Saw that the culture could translate well to other countries as well
 Liked that the company did not have any debt
 Was 15% of their portfolio for a time
 Generated high return on new stores and the stock price went up
 But then they started doing
things he was not comfortable
 Lower returns on
 Aggressive stock
 Bought back their
own shares using all
their free cash flow
(FCF) and debt
o At too high a price
 Sold out by 2006
 Still liked the characteristics on the company
 But, results suffered from misallocation of capital
 Price dropped a lot during 2008-2009 and they bought back in
 Now the 3rd largest position
o Now more focused on returns
o Now paying a dividend
 Less cash lying around
o RG Barry (DFX)
 Sells slippers that are sold at Macy’s and other retailers
 Sold a low price item but had a manufacturing platform that was based on high
cost labor
 Outsourced to China to cut costs
 Are the largest shareholder of this company
o Goldman Sachs (GS)
 Have always admired the culture
 Were concerned about the aggressive culture
 But crisis came and the competitors went away
 This is a business they want to own, despite concerns over future returns as a
result of regulations
o American Express (AXP)
 Great global brand with loyal customers
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Wells Fargo (WFC)

 WFC came through the crisis better than ever
 Best management team
o US Bank (USB)
 #1 in the west
o Stacked (Private)
 Take a store that would akin to the size of a California Pizza Kitchen (CPKI)
 Menu that specializes in burgers, salads and pizzas
 Get seated by the hostess and there is an iPad on the table that allows you to
customize your order
 Hostess brings the food when it is done
 Swipe credit card on iPad when you are done
 Raised $10M to open 4 stores
 LA, San Diego and Orange County
o All mall locations so far
 Looking for a non-mall stores as
 Looking to franchise it around the country
o FFH+ BRK+ SBUX+ Cash represents about 50% of the portfolio

- Q&A
o Given his real estate background, does he have plans to invest in CMBS? Can they take
advantage of future dislocations in that market?
 Would not invest in companies that manage real estate
 They can do that themselves
 Saw how REITs managed their properties and do not want to run their
company that way
 Thought that the financial crisis would create opportunities
o But it didn’t happen- too much capital and cap rates are too low
o Leverage is so prevalent these days
 You need leverage to make great returns
o Can he give some examples of companies they invest in with exposure to Brazil?
 Don’t invest in companies in Brazil
 Most obvious company is Coca Cola (KO)
 They wouldn’t look at KO because you can see a Coke sign everywhere
when you travel the world
 But, AXP is a good example
 Emerging countries will use more credit cards in the future
 Do not do much in commodities
o Does he have opinions on the housing market?
 Housing market—they were careful not to be anywhere near it in 2006 and 2007
 Liked what Prem Watsa said would happen with housing
 Liked what he did with CDS
 Housing will bottom at some point
 Then there will be the need to build some new houses
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 On his street all of his neighbors owned 5 houses

 That was unsustainable
 Not an industry that they are going to mess with
 Like less cyclical and commodity-like opportunities
 His friend who is a CEO of a homebuilder is not optimistic—although he was at
first more optimistic after the crash
 There are too many houses in foreclosure
o They like companies that they are comfortable with. How can they invest in banks given
that? How can they trust management teams?
 Tougher to know what is going on in insurance policies or bank loans
 You can get to know management
 When you listen to WFC talk, it is totally different from other banks
 Knowing that these industries were not going away, they believed that
the ones who were not doing foolish things would come out ahead and
with a stronger market position
 We’re willing to own Fairfax going into the crisis
 Bought WFC too early
 Think the management team is good—want the team to be their partner
o What was is about the valuation of SBUX in the 1990s that attracted them? Didn’t it have
a really high multiple?
 SBUX sold at a large P/E but there was a lot of demand and room to grow
 Almost didn’t care about the multiple they paid
 Now they have 15,000 stores and the price really makes a difference
 Have to think about international growth now
o How many stores can there be in China?
 No brainer in 1998—could have paid 10% more or 10% less and it
would have not mattered
o What attracts them about preferreds during the crisis?
 Have a lot of cash and wanted to park their cash somewhere that generated
 Look at preferreds with variable rate features from banks like GS
 Not a buyer today because the 20% discount to par has closed
 Looking for a future opportunities to buy more
o Don’t pay much attention to the macro data, but they have made good calls. What other
info or data do they look at?
 They look at the market prices and valuations of the stocks in the same sector as
companies that they own
 Are they higher or lower than the companies they own?
o Try to assess the state of the market with that framework
 Don’t try to guess when the market is going to peak
o When they were buying SBUX during the lows, how did they size it?
 The second time they he was thinking of buying SBUX, he remembered that he
had said he would never buy until they had a SSS decline
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 But he bought when it went below $20.

 Bought under $20 and bought more around $10
o Knew the business was not going to go away
o The accounts owned about 10% SBUX
 Today they are thinking about trimming their position and would not be a
buyer today
o What about the overlap between their holdings and those of BRK? Are they ever
concerned that the overlap makes them too concentrated since they own BRK as well?
Are other segments of the markets not represented?
 When he was buying CRE in Denver, he put all of his net worth in there
 He knew Denver real estate and knew he couldn’t lose
 Would rather own more of what they are most comfortable with
 Do not want to spread their risks into things they don’t understand
 When you have good management, they are likely to not make mistakes
 When they see that a market was going to change, they chose to get out—like in
the real estate markets
 But good managers have the ability to avoid bad markets
 Even if a company has a great brand, you have to pay attention to
management too

Speaker #5

Opportunities in a Complacent World

Steve Romick- First Pacific Advisors

- Now he has all of the time in the world after not having to present in years before
- He has no idea what the future holds and the present lacks clarity
o Looks to find something in the rubble that looks attractive
o Looking for cheap stocks is like trying to ski down Aspen in the summer
- We blew it after the crisis
o People are complacent
o People claim to look for safety but they are seeking risk
o People believe in the government to stop bubbles
 Romick does not believe that people who didn’t see bubbles in the past will be
able to stop them this time
- Hard to have confidence in the US governments numbers
o GAO report said that the government’s financial statements have material weaknesses
 If they say there isn’t inflation, that is only because they don’t eat or drive
 Government is talking its book
 Believe there is much more inflation than is being reported
o Government is increasingly hiring more people though
- We have a debt problem
o Mandatory spending keeps on increasing relative to GDP
o Only 16% of the budget was on the table to cut in the newest Obama budget
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 If we were really serious about cutting expenses, everything would be on the

 Social security is morphing from benefit to an entitlement
 Great deal for people as the collection age has not gone up with life
 Not saying that we should get rid of social security
o We just shouldn’t add to the obligations
o How does the government keep spending money when consumer cannot?
 Successively diminishing return on productivity of debt in the US
 Government is supplementing Treasury demand by borrowing short
 40% of debt maturing in the next 2 years
 Have to convince lenders that we can pay off our debt and that the dollars will
be still be worth something then
 Given that, he doesn’t know who is buying our debt
 CBO has sanguine estimates—CPI inflation projected to average just 2% until
 These unrealistic numbers keep politicians complacent
 Even so, they have interest expense getting so high in the future that it is
more than defense spending
 5% increase in interest rates would cause interest expense as a percentage of
revenues to go from 6% to 21%
o Government spending spigot continues to be open
 We are confusing medicine for narcotics
 We haven’t taken the pain
 We need assets to fall in value and prices to clear
 We are in a recovery is between 2 crises
 Children will pay for the sins of their fathers
o The New Monopoly game
 Eliminated paper money—creating electronic money
o One path leads to inflation and that can be seen in commodity prices
 It is hard to imagine that the increase in monetary base will not end up in
inflation down the road
o FPA’s returns will come from what they don’t own rather than what they own
 Anxious about the returns on the US dollar
 Cash is building in the portfolio
 Looking for large business with foreign revenue sources
 Not many opportunities
 Margins are near all-time highs for US companies
o Wall Street said that there is always an opportunity
 Analysts have a terrible track record
o Using a cyclically adjusted Shiller P/E, the S&P 500 trades as 23x
 Small caps trade a 20% premium to large caps
 Fewer analysts—less efficiently priced?
 Easier to understand?
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Grow faster?
o This is a myth based on Russell 1000 and 2000 data
 Large caps stocks have grown faster since 1995
 Large caps have more exposure to foreign
 More likely to be bought?
o FPA is basically short M&A
o FPA is positioned for inflation
 Largest sector is energy
 Have a big position in an insurance broker
 Subprime whole loans at $.45 on the dollar
 Private REIT in farmland
- CVS Caremark (CVS)
o Likes the trends in pharmacies
o Lots of growth in the old age
o Pharmacy utilization should be up
o Medicare market is growing fast
 32M people will get
coverage in 2014 – if it
 Free option—
could be a 20%
bump to the number of prescriptions that CVS already writes
o Drugs are 10% of health care spending
 Patient adherence to prescription regimens saves money
o CVS and Walgreens (WAG) are both best positioned
 7100+ stores
 Great footprint and opportunity to gain shares from independents
 Independent share is down to 20% and has halved in the last decade
o Is mail order a real threat?
 Small affect over time—only 19% of the market consistently
o Lots of drugs coming off of patents
 Generics come on and it is beneficial to CVS
 Better margins—peak in 2012 since they make better margins on
 Now self-distribute generics and can capture the margin there
o People care about private label versus branded when you can taste the product
 But people don’t care as much when you can’t taste them
 Production problems and JNJ recalls are helping private label sales
 Higher gross margins but lower price on these products
 Could increase operating income by 3.5%
 Tesco has 50% private label products
 CVS has a lot on runway on this front
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Pharmacy Benefit Management (PBM) business

 Almost 50% of CVS’s sales and 1/3 of the profits
 PBMs aggregate buying power to get lower prices
 Induce pharmacists to switch from branded to generic
 PBM and retail business allows them to offer mail order business as well
 15% of Caremark’s customers use maintenance choice
o Could grow even more
 Challenges
 Lower future rebates
 Legally mandated transparency of drug purchase costs
 Decided to hedge out some of the PBM risk
o Management
 Skilled operators and capital allocators
 Retiring CEO has $300M in share exposure
 CVS has been returning capital to shareholders
 $3-4B in buybacks per year
 Added to a dividend the yield jumps a lot
o CVS has the opportunity to reduce inventory
 By 2013 their goal is to be on one platform
 CVS estimate of $2B in inventory savings by yearend 2013
o Trading at 6.6x 2011 EV/EBITDA
 Caremark can outperform its peers but they have still hedged out the PBM
exposure by shorting other PBM companies
o Could they spinoff Caremark?
 Want to let the company execute on its plans regarding
 Express Scripts and Medco could be likely buyers if CVS cannot improve the
PBM’s operations
o The stock is not a homerun and is not as cheap as it was when he started writing the
- Goldlion Holdings Limited (Hong Kong: 0533)
o Hong Kong based company that is a
wholesale clothing and apparel brand
o The company has $400M market cap
 Float is about 1/3rd of that
o It is like the Polo of Hong Kong but is
not as nice as Gucci
o Maintains quality above all else
 Do not want cutthroat prices
o Market share slide shows 6% market
share in the fragmented Chinese apparel
 Ranked 6th in a Credit Suisse brand survey in China
o Positives
 Rapid growth
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 ROC: 49%
 High margins
 Optionality
 Real estate assets
 6.3% dividend yield
 Has been public since 1992
 Has a name brand auditor
 Has lots of cash and some investment properties
 Has not de-worsified in recent years
o Current market cap is 3.26B Hong Kong Dollars
 Effective multiple of 2.6x trailing EBIT
 Upside of 50-100% , supported by the dividend
- Value investing is the best means to preserve capital and provide adequate growth over the long
o Let thoughtfulness and patience be the driving philosophy
- Q&A
o When it comes to CVS, what is your the appraisal of the current management?
 Acquisitions are not likely because they have already bought what they could buy
 New systems are going to help the company drive inventory out
 Can reduce the number of SKUs and stock outs
o You see out of stock positions at CVS and not at WAG
 Very high marks for management
o What do you think of Goldlion’s corporate governance?
 China is the wild west
 There have never been insider dealings with this company
 Has been public for 20 years
 The paper trail and history give him comfort
o Inflation calculations have changed over time. Also, what does P/E 100 years ago have to
do with today’s?
 There are appropriate changes to CPI that should be made overtime
 Doesn’t buy that the high inflation numbers put out by John Williams of
ShadowStats are accurate
 The problem with the Shiller P/E chart is that the data on the might not be great
going way back
o Isn’t it true that Goldlion has been leasing a lot over the last few years?
 They are not a retailer
 Even if you adjust ROC for leases, it is still very high
 50% is ridiculous
o Very large ROC even if you incorporate leases
 Only own the stock in small funds due to the small float and the inability to
accumulate shares
 If you want to invest in China, there are no guarantees
 But there is a margin of safety
 He is trying to swing for a bigger hit; not just looking for a compounder
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 If you can buy the asset at a large enough discount, you can make money
o For Caremark, are there other headwinds?
 Drug prices are going to be transparent
 Corporate customers will see the price of drugs
o May demand lower prices
o He has no idea how to handicap that
 Caremark had been losing share but the new management team looks set
up for success
o FPA is hedging out industry risk
 Thinks they are going to stabilize and gain market share
o Winning lower margin but large accounts
 Insurers will be getting into the business
 Especially on the specialty pharmacy side
o In terms of rising interest rates, what would be the catalyst?
 2 catalysts
 If we actually get inflation
o Could be hard to see with high unemployment and low capacity
o We could also import inflation in commodities
o Bernanke mentioned inflation 86 times in his most recent
presentation and deflation only twice
o One day the inflation will be here without much warning
 Lenders goes on a buyer’s strike
o Will lenders want to get paid in the same dollars they are lending
money in?
o Lenders may want a higher rate of interest, even without

Speaker #6

Hockey, Snow and Value: Uncovering Bargains North of the Border

Guy Gottfried- Rational Investment Group

- Guy is 29 years old

- His fund launched during 2009—40% returns per annum
o Average cash of 27% since inception
o Has not realized a loss yet on any investments
- Americans are concerned with US monetary and fiscal policy
o Canadian market offers an opportunity
 Economy has been strong
 11 years of budget surpluses before the recession
 4th lowest corporate tax rate in OECD
 Lowest debt to GDP of G7
 Strongest banking system in the world for 3 straight years
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 No crazy mortgage products

 No bailouts and not one bank even cut its dividend during the crisis
 This is an inefficient market
 Very few value investors
 People are obsessed with Canadian resource stocks
o Mining and oil stocks comprise about 33% of all of the listed
companies in the TSX
o There is an entire economy that is overlooked
 Small markets

o Morguard Corp (Toronto Stock Exchange: MRC)

 Market cap: $780M
 Has great business and is dirt cheap
 Originally a distributor of auto parts
 Controlling shareholder turned around the operations, sold them and had cash
to invest
 Real estate stocks had a slump in the 1990s in Canada
o Bought stakes in 5 large real estate firms at this time
 4 parts of the company
 Wholly-owned
 Other investments
 Investment in
Mortgage REIT
 Management and
advisory business
 Extremely cheap
 4.8x FCF, net of
Morguard REIT
 Implied CAP rate of 13% on its portfolio
 Valuing its owned portfolio below $0
o Getting paid to own those attractive assets
 High quality assets
 Outstanding capital allocation history
 Several catalysts possible that can unlock shareholder value
o Why is it so cheap?
 Most real estate stocks in Canada are REITs and pay dividends
 Pays out less than 10% of FCF
o Likes to retain capital rather than pay it out
 Illiquid due to CEO large ownership
 Not big enough for large institutions
 No sell side coverage
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Does not have a promotional management team

o Owned portfolio
 Assortment of apartments, industrial, retail and office properties
 Trailing NOI of $152M
 10.3K apartments
 Apartments are the most stable, lowest cap rate real estate asset class
 97.5% occupied apartments located in Toronto, Canada’s biggest city

o Morguard REIT (Toronto Stock

Exchange: MRT-UN)
 Owns 8.3M square feet of real estate
 Morguard owns 45%
 $35M in management fees and
dividends each year
 Dividend is sustainable
 Zero risk of losing MRT as client
 Steady stream of growing fees
 Capital source, exit strategy for fully
valued properties
o Advisory- Property Management Segment
 Real estate management services to Morguard and other firms
 Wholly owned subsidiary that provides $20M in NOI
 One of largest property managers in Canada
 Smaller NOI numbers than generated by the owned portfolio
 So the market overlooks this segment
 Low CAPEX business
 30% pretax margins
 Grew even during the recession
 Stable cash flows and revenues
 Want to grow this business and they have been successful
o Capital allocation and management
 Have in a great capital allocator in a capital intensive industry is really important
 Company has a strong balance sheet and discipline
o Can create opportunities by buying during the panic
 Rai Sahi is an owner operator who owns 50% of the company
 Has aggressively bought back the stock
 Have not issued an option in a decade
 Conservative balance sheet with a 50-55% loan to value (LVT) ratio on the owned
 This ratios is very low given that a lot of the properties are apartments, which
are highly leverageable
 Conservative account
 FFO includes PP&E deprecation on non-building items
o Peers inflate FFO by adding back all depreciation
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Very conservative company

 Has bought back 38% of its diluted shares since 1996
 The company is buying large blocks of stock
 Has continued buying throughout its history
o 2006-201: 11.8% of shares bought back, all at a great price
 This is what we look like as value investors
o Acquisitions
 Sahi is a corporate raider and has performed takeovers at fire sale prices
 Has done 5 major takeover recently
 Goldlist Properties
o 17 multi-unit apartment buildings
o $335M price, including assumed debt
o Busted IPO
o Morguard bought 40% of the IPO at $9
 Was able to cut the offer price of the IPO by 10% and
reduced the dividend the owner pulled out of the company
 Revenue Properties
o Gained control of the company at an average cost of $1.48
o Privatized RPC in 2008 by buying the remaining 27% at $12 per
 Advisor hired to provide a fairness opinion at $420M
o Implied cap rate of 35%
o Bought from Mutual Life Assurance
o Generates $20M in per tax income now and was bought by $33M
o Valuation
 7.1x FCF (14% FCF yield)
 High quality business
 If you back out MRT, the core business free cash flow multiple is 4.8X
 Owns MRT for strategic reasons; not for operating reasons
o Instructive to see how the market is valuing the rest of the company,
 Cap rate calculation
 NOI/Market Cap implies a cap rate of 12.8%
o For the owned portfolio alone
o These are Toronto apartment buildings that usually sell at a 5.5% cap
 Even commercial and industrial properties in Canadian
command a 6-7.5% cap rate
 If you subtract out the value of the other segments, the owned portfolio is
valued at less than $0—actually negative $79M
o Guy is being paid to own 10.3K residential units and 6.9M square
feet in commercial space that are generating $150M in NOI
o Catalysts
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Create a new REIT to hold investment properties—could sell properties to a REIT at

current market prices
 Cap rates on apartments are in the 5.5% to 6.5% range
o Implied cap rate on the portfolio is currently about 13%
 New stream of income
o Would become property manager and advisor to those buildings
 Could sell properties to MRT
 Morguard investors are clamoring for the company to expand
o Analysts want the firm to grow its portfolio
 US expansion
 Valuations are rich so there is little to do in Canada
o Undervalued acquisitions are likely on the horizon in the US
 Could profit from compression of the difference between price and intrinsic
 Also get growth in intrinsic value
o Q&A
 Any concern that the supply of apartments is going to increase?
 There are a lot of cranes there, but there are 10x as many in Israel
 Residential construction in Toronto is on the condo side
o There are few apartments
o Condos are hotter because more can be squeezed out
 Cap rates are extremely rich in general
o Company knows this and hinted that it might try to monetize some
the assets at those rates
 Takes a long time to do so though
o Are the controlling partner’s incentives aligned with shareholders?
 He doesn’t think Sahi plans to buy out the company—the stock fell to $13 in the
crisis and he could have bought it out
 Now it is at $60
 Does not that that Sahi wants the price to stay low so that he can buy it
o He could have bought it over the last 20 years are much lower prices
 Thinks he wants to grow the business instead
o But you never know 100%
 Even a margin of safety can protect you from something like
 The market has a mind of its own—the price can go up no matter what the
CEO wants
o How do you differentiate between skill and being in the right place at the right time (referring
so Sahi’s ability to buy low and sell high)? Does the skill move abroad—to the US?
 Company already has been active in the US
 Great management can create value in any environment
 Most companies operate with the herd
o Make acquisitions when times are good and do not buy during panics
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Morguard has been able to maintain its results in good times and bad
o Can operate better in down markets
 Cheap price with a management that knows how to deploy capital
o Question from Peter Brotchie of Union Trust Mortgage Corporation: If they do not spin the
properties off, is there a lot of maintenance CAPEX in the pipeline, based on the age of the
 No, they have a normal CAPEX program and Guy does not expect a large ramp in
CAPEX in the coming years
o How accessible has the management team? Can they be influenced?
 Not amenable to activism
 Management has been buying back stock at the right times and making deals at the
right price
 Has already been selling properties to MRT without pressure
 Slowly embarking on this strategy
 When you are aligned with good owner-operators, you don’t need to be an activist
o Alex Rubalcava of Rubalcava Capital Management: How did he value the asset management
business? Has the CEO sold or bought shares?
 There is no exact science to valuing a business
 Pretax income multiplied by 12x
o Did not look that closely at comps because the company is so cheap
 CEO has bought shares in 2008 and 2009 in the $30 range
 Has never sold a share
 Through the company buying back shares and buying shares on his own, he
has taken his stake from 20% to 50%
o How old is the CEO and does he have kids in the business?
 Daughter works for the company in the US
 He is in his mid-60s
 No kid who is an executive or who is highly paid
 No evidence of nepotism
o What is the variant perception here? Why is the stock being ignored?
 He is not aware of what he is missing
 Market is looking at:
 Illiquidity- can buy a few millions of dollars in it
 Business is a bit obscure
o Owned portfolio dwarfs the numbers of those of the property
management business
 Shares a conference call with the REIT—95% of questions go to the REIT
o Very low profile company
 Does not need to be promotional
 Pays a low dividend
Speaker # 7

Global Value Investing: Guidelines Opportunities, Pitfalls and Actionable Ideas

Ori Eyal- Emerging Value Capital Management
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

- Has been running this firm since 2008

- Learning experience
o Had the opportunity when he was working at Deutsche Bank to participate in a Russian
power plant IPO
 The ultimate decision was based on his meeting with the CEO
 The CEO said he was issuing equity and said he was doing so because
equity was free and debt had to be paid back
o He didn’t do the deal and he was lucky because it performed
very poorly
- Lack of concern for the rights of minority shareholders is prevalent outside of the US
o In the US companies at least pretend to care
o Do not even pretend to care in some other countries
- Strategy is to take the principles of value investing and apply them all over the world
o Guidelines
 You have to do detailed research on the company and the country you are
investing in
 Some countries are more attractive than others and you can’t just invest
in every country
 Don’t chase GDP growth
 No correlation between GDP growth and stock market returns
 Why not?
o Expected GDP is priced into the stocks you are buying
o Benefits of growth may accrue to new firms not in the basket of
stocks you purchased
o Benefits of the return could get stolen, inflated away or
 Why is his cash in US dollars?
o Emergency market and commodity currencies are likely to
appreciate versus the dollar over time
 Not going to be a straight line though
o When they can invest in country like these, they can get an
additional tailwind
o But, they need cash when there is a crisis
 Flight to safety occurs as people move from risky assets
to US dollars
 Dollars are likely to be up in times of crisis, exactly
when they need their cash
 One billion new capitalists in emerging markets
o People are moving to the cities and they embrace capitalism
o They become an emerging middle class
o Look for businesses that have good management, trade at a
reasonable price and that are selling more to emerging markets
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Promoter De Informaciones SA (NYSE:PRIS)

 PRISA is a levered media company
 Share class arbitrage opportunity
 Merged with a US SPAC (Liberty Acquisition) at the end of last year
 Created new shares
 B shares are a lot better
 Yet, they trade at almost the same price
 Strategy is to short the A shares and go long the B shares
 B shares eventually become A shares
 Mandatorily convert in 3 years
o Shareholders can convert at any point
 A shares cannot trade at a higher price than the B shares
because people would just convert
 The spread cannot turn negative
 B Shares pay a mandatory dividend while the A shares do not
 1.6 euros per share
is the NPV of that
o This is not
the whole
 B Shares offer downside
 As long as A shares
trade above 8 euros,
you get a 1 to 1
 But, if they trade below 8 euros, you get extra A shares
o Do not lose money until the A shares fall below 6 euros
o At very least he thinks the B shares are worth 2.6 euros more than the A shares
 Price could be about 4.2 euros higher than the A shares
o This is a lot considering that the A shares trade at 8 euros
 About 50% upside and little downside
o Catalysts
 Dividends are going to start to be paid
 Hasn’t been paid yet—we don’t know when it is going to be paid
o Likely between now and September
 Bad news from PRISA group or macro bad news from Spain
 Would highlight the value of the downside protection
o Larger funds have not been able to borrow the A shares
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 If you can’t borrow them (exchange A shares for B shares), just go long the B
 This is a good opportunity even if you can short the A shares
- Research the country: Israel
o Often finds very interesting opportunities there
o Israel has a well-managed economy and barely felt the economic crisis
 Has the most NASDAQ listed companies and start-up companies outside of the
o Shareholder protection and rule of law are present
o Favorable business environment
o Highest rates of entrepreneurship among women
o Higher life expectancy than that of the UK, Germany and US
o Discovered a huge offshore natural gas field
 Will wean Israel off of foreign energy sources
o Most well regarded research universities in the world

- G. Willi Food International (NASDAQ: WILC)

o NASDAQ listed company
o One of Israel’s largest food
 Search the world for
successful food
products and work
with the maker to
create kosher
 Specializes
in Kosher
 Appeals to Muslims and other non-Jews
o Viewed as healthier due to less animal fat
 80% of sales are into Israel
o 20% rest of the world- mostly US
 Expanding rapidly internationally
 Growing 15% each year
o Divisions
 Gold Foods
 Shamir Salads
 51% interest
o Financials
 $100M in sales
 9.5% operating margin in 2010
 $8M in net income
 $51M in cash and essentially no debt
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Market cap is $100M

 EV equals $50M
 Should earn $10M in 2011
 Net of cash, the company is trading at 5x this year’s earnings
 Looking to acquire a distributor in the US
 They are not going to overpay
 Want to get their food on the shelves of US stores
 If they can’t acquire one, they will pay a dividend
 Are in talks with private equity firms
 If it gets sold, he only get a onetime bump
o Hopes they don’t get bought out
 This is a compounding machine
o Well managed, recession resistant business
 Literally trade on the NASDAQ—not an ADR
- Q&A
o Regarding PRISA, would you consider writing a covered call on the As if you can’t
borrow the A shares?
 Does not think they have listed options
 Would love to create a synthetic short or buy a put
o Does he have any thoughts on the turmoil in the Middle East? How does it affect this
 Doesn’t affect Willis Food in any way
 In fact it could benefit because other foods get rationed in the event of a
 The main issue is that Iran is building a nuclear bomb and a mechanism to
deliver it
 Egypt and Libya situations are not as important as what is going on in
o What exactly does the company hope to achieve with a US distributor? US market for
kosher foods is well developed already.
 Willi Foods already has products on shelves in US
 Believes that there is a shortage of strong kosher brands
 Third party distributors eat up profit and control of shelf space
 Company thinks it could distribute much better if it owned its own
 Has not disclosed any names of who the company is interested in buying
o Can you elaborate on the 2.6 euros and 4.2 euros upside on PRISA group?
 Equation: Dividend stream+ Downside Protection (3 year at-the-money put
option)= 2.8 euros
 Extra value comes at the expense of the A shares
o 2 A shares for every B shares
o If the B shares gain 2.8 euros then the A shares lose 1.4 euros
o 1.4 euros + 2.8 euros= 4.2 euros
 How did this opportunity come about?
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Merged with Liberty Acquisition and the merger was complex

 Brokers can’t even find the B shares
 Market is just not recognizing what is going on
o The company will pay a dividend of at close to an 8% yield
o How is Willi Foods positioned to handle rising food costs?
 Rising food costs are a negative for every food producer in the world
 Company is fully aware of it and have hedged in the past
 Got it wrong and stopped hedging
 They do try to match currencies though
 May depress margins in the short run
 In the long run the costs have to be passed on
o Question from Michael Kao of Akanthos Capital: Could the company increase the float
or add A shares?
 It is possible to issue more A shares
 May also be able to issue more B shares
 The SPAC was mostly cash and the result of the merger was a de-levering
 So, the company is not that levered and has little reason to issue equity

Speaker # 8:

Lessons from 15 years in Micro-Cap Land

David Nierenberg- D3 Funds

- D3 Funds
o Concentrated portfolio
o Large block stakes
o Look for undervalued growth micro caps
o Private equity- like model
o Take 10% stakes
o Busted growth companies
o Not activism—constructive engagement
 Want to be partners in unlocking value
o Almost all of the money in D3 comes from individuals and families
 Have a multiyear lock up but investors stick around after it expires
o Avoid leverage
o Most of his own net worth is in the funds
o During the 12 years beginning in 1999, the firm has compounded after fees at 11.4%
- The macro backdrop matters
o Painful lessons learned in the recent crisis
o Sailed through the 2000-2002 correction
 Actually gained over the 3 year period
o The 2008-09 period was payback time
 Had to rethink how to preserve capital
 Cheap stocks got cheaper
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 40% of companies in the portfolio were trading at less than net

 Smallest companies were illiquid and the stocks went down more
o Average market cap: $400M
 Needed to figure out how to profit from the pain
o Report by Ed Easterling of Crestmont Research
 Market likely remains in a bear market
 Multiples may trough at 8-10x P/E multiple
 Increasing inflation and slowing growth are likely to compress P/E multiples
 Market is likely to remain volatile
 Slow growth
 Reinhardt and Rogoff’s rule of 90% debt to GDP
o When countries go through that threshold growth starts to slow
 Aging population in the US will hamper growth
 Need to have a point of view and focus on preservation of capital
 Even if they are wrong, their strategy will not hurt them
o Strategic changes
 Will now sell at fair market valuation as opposed to target valuation
 Unless they have proprietary insight that the company could be worth far
more than it is
 Cash is not trash
 Now focusing on what appropriate purchase levels are for future purchases
 Defensive valuations
 Started returning to public board service
 Shift portfolio to higher growth businesses and higher margin geographies
 Emerging markets
 Natural resources
 Mobile computing
 Seek companies that pay regular and special cash dividends
 45% of returns came from dividends in the last century
 Shorting again
 Invest in businesses that benefit from inflation
- Sample portfolio companies: AACC, BABY, ESIO, HDV, HPY, MBAC, MDTH, MOVE,
- Growth investing
o Multiplus
- Activism
 If you own more than 10%, make a difference
 As tech growth slows, do something smart with the cash
 Invited to be on the board in the last year
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

- Multiplus (Sao Paolo Exchange: MPLU3)

o Loyalty program operator
 One of only 2 publically traded ones in the world
 Busted IPO
 Spun out of leading Brazilian airline—Tam
 Believe that the company rushed to market because it went to market before it
had a CEO or CFO
 Revenues generated from
the sale of points, breakage
and float
 Breakage- points
expire unused
 Float- 18-24
months of float
before the points
are typically
 Growth in credit card usage in Brazil: 22% CAGR
 Personal consumption expenditures: 11% CAGR
 Passenger traffic: 9% CAGR
 Wealth distribution now includes a middle class
 World cup and Olympics are coming to Brazil
 No inventory and negative working capital
 Float at around a 12% rate
 95% of earnings are to be paid as dividends
 Yield will be 17% in 2011
o Combined special and regular dividends
 6% estimate yield in 2012

o MBAC Fertilizer Corp (Toronto Stock Exchange: MBC)

 Company is currently building a phosphate mine in Brazil
 Low CAPEX, project is fully funded and has received of all of the permits for
 Should be cash flow
positive in Q4 2012 or
early 2013
 Twain: A mine is a
hole in a ground with a
liar in front of it
 CEO and CFO were
involved with Yamana
Gold (NYSE: AUY)
 Another D3
investment company
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Know phosphate mining very well

 Economist article on the miracle of the Ceraddo area of Brazil
highlighted the vast resources
 Brazil has by far the most potentially arable land of any country
 Brazil leads the world in a number of different commodities
o But it needs fertilizer—especially in the Ceraddo region
 Land needs 7x the amount or fertilizer needed in the US
 Landed cost advantage
 Cost advantage over imports and domestic competitors
o Exploration and M&A
 Expansion into Itafos resources
 There are a number of M&A opportunities
o 3 different valuation models
 Valuation per ton of the resource
 EBITDA multiples
 No matter how they look at it they see short term upside potential of 35% but it
could be as much as a 4x
- Generic Observations about boards
o Too much time spent on the wrong things and not on the critical things
 Box checking compliance idiocy
 Sarbanes Oxley
 Fighting the last war
 Management dog and pony shows
 Solution is part of the problem
o Interpersonal dynamics suppress questions, doubt and consent
 Group think happens too frequently
o Compensation is excessively complex and ineffective
 Rigged to insiders
o Balance sheet assets are seen as corporate assets and not shareholder’s assets
o Not enough skin in the game
 Too many options and RSUs
 Not buying stocks with cash
- What does he bring on board?
o Focus
o Sense of urgency of an owner
o Asking questions with the willingness of child
o Looks at cash requests and capital allocations based on opportunity cost

- Electro Scientific Industries (ESIO)

o Leading supplier of laser based
o Financial fortress
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Land at book and Cash came to $7.20/share

 ½ of the share price
 No debt
 Positive cash flow from operations every year
o What is he doing?
 Succession planning
 Company has an old CEO and Chairman
 Capital allocation decisions
 Emphasis on the imperative for cost reduction
 Manufacturing and cost of quality
 Linkage between compensation and performance
 Focusing the firm on performance

- RadiSys (RSYS)
o Leading provider of hardware and software embedded computing systems for next
generation IP networks that enable telecom, medical and military/aerospace customers
o A game changing acquisition and
management change happened
 Acquired Continuous
Computing for $105M
 Current CEO will become
Vice Chairman of
combined board
 Acquired CEO will be
combined CEO
 Opportunity to reduce
customer concentration
and to improve margins as the acquired company has much higher margins
o Priorities
 Succession planning
 Rational, analytical and outward looking process for capital allocation
 Cost reduction
 Focus on operations
- Q&A
o What is the preferred way of aligning management and shareholder interests?
 Good idea to ask people what incentives light up the scoreboard for them
 No one size fits all
 All companies and people are different
 Start with the people on the compensation committee to have one-on-one
discussions about how to motivate people
 Agnostic about the mix
 But it has to be linked to performance
o Growth in EPS and total shareholder return
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Not averse to working with consultants to unscramble the mess

 Compensation is a non-delegable duty
 Too often people use consultants and lawyers and consultants
o What can be done to reverse the trend of management ripping off shareholders?
 Proxy advisory business has mushroomed into a powerful movement
 May be faith-based sometimes
 These firms are so powerful now
 Being on the board is challenging because it requires subjective decisions
 Can’t always find a great formula for compensation
 There should be more situations in which large block shareholders are asked to
become a part of the board
 They should be able to rock the boat just enough to create value
 Board members should be required to have real skin in the game
 Not RSUs and not options
o Question from Aaron Edelheit of SabreValue- Said he was hurt in 2008 as well. Is there
not every 20 or 30 years an event that causes small cap value to go down a lot? Does
what happened in 2008 helps perpetuate the outperformance because the competitors are
 100 year floods hit the financial markets hit a lot
 Increasing use of complexity, leverage and electronic trading almost
guarantee that they will happen again
 This is why they went through the changes they discussed in the slides
o Apparently there is tons of corruption in Brazil and lots of payoffs. How does he feel
about that?
 US-based companies have more trouble getting contracts
 MBAC is Headquartered in Toronto but all of the members of the management
team live in Brazil
 Brazil is a very tough country to do business in
 They feel really great about the management team
 Need to bet on the right people
o Alex Rubalcava of Rubalcava Capital: The technology transition at RSYS has taken a
long time. Why is that? Regarding MBAC, should they become a producing company or
sell out before production?
 Should not say much about RSYS’s situation aside from the fact that the
technology transition has taken longer than they had hoped
 In the case of MBAC, they prefer that company becomes a producer
 But everything has a price and would love to be bought out at a huge
 If it were more early stage they might want them to prove out and then
sell out
 Management team is populated by operators
 This things is up and ready to go

Speaker #9
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

An Update on St Joe and out Analysis of Howard Hughes Corporation

Glenn Tongue and Whitney Tilson- T2 Partners

- Largest short: St Joe Company (JOE)

o Bruce Berkowitz of Fairholme
Capital responded to David
Einhorn’s (of Greenlight Capital)
short presentation with a
presentation that showed a lot of
beautiful pictures of Windmark, a
St Joe development in Florida
o Many of the lots in Windmark are
in foreclosure
 But St. Joe sold all of those
off so they have no
exposure to what is known
as Phase 1
o The bubble burst before they were able to sell all of the lots off
 Only 42 lots sold and only a few homes were built
 No beachfront properties in Phase 2 lots
 Phase 1 houses are beachfront
o Photos in the Fairholme presentation appear to be staged
 No sales are being made
 Foreclosed lots from Phase 1 are competing with sales of St Joe’s lots
 Shows pictures of stores and restaurants that had actually been shut down even
before the presentation was released
 Many of the pictures have no people in them
 The people doing construction may be doing it because they have contractual
o What’s Windmark worth?
 It is being carried on the balance sheet at $160.9M
 But Greenlight valued it at only $17.8M
o But overestimated how much lots were actually selling for
 May only be worth $12.25M
 They don’t think St Joe is a $0 because it has net cash on its B/S
 Just overvalued by a multiple of 2x-3x
 Company has an incentive not to write down assets because the market will catch
on that the stock is completely overvalued
 Delayed their 10-K release but still took no impairments
o Recoverability test—if undiscounted future cash flows added up
are worth as much as the carrying value, then no impairment is
not necessary
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Management assumed 7% price appreciation in the properties for

17 years!
 It is claiming that the selling period for the residential
properties is 17 years and is 35 years for the commercial
real estate
 There is no precedent for this
o St Joe has a lot of Timberland but that cannot make up much more than $7-$8 of the
stock price
o Berkowitz has said that the current state is depressed but the market will pick up and
people will buy and develop these lots
 This is the Redneck Riviera
 Population is poor , high unemployment, poorly developed
 Who is going to be buying these properties?
o There is 8 years of condo inventory in nicer areas of Florida
 These lots may never be built

- Long position: Howard Hughes Company (HHC)

o HHC owns, manages and develops commercial, residential, and mixed use real estate
o Has 3 types of properties
 Master planned
 Operating properties
 Development
o Spun out of General Growth
Properties (GGP)
o REIT structure is not ideal for
owning development assets,
master planned communities
and assets whose cash flows do not reflect future potential
 They would have stayed in GGP if the assets had not been very attractive
o They believe that HHC has undervalued, high quality real estate assets in premier
- Basics
o Price: $65.21
o Warrants: 10.7M
- Spinoff characteristics
o Spun out of a reorganization
o No research coverage yet
o Many GGP investors only own REITs so they sold the shares post spinoff
o The only assets that the management team cares about are in HHC
o Insiders are incentivized
- Very difficult to value the company and have no idea what it is worth
o Seems to be limited downside and they think it is worth way more than it is trading at
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Insiders own 50% of stock, including warrants

o New CEO purchased $15M in warrants and President purchased $2M
o The plan sponsors (Brookfield, Pershing, Fairholme, etc.) put in 5.25M additional shares
for $250M
o Very low leverage
o Great management team
o Major shareholder have very big stakes
 Pershing skewed its warrant ownership to HHC as opposed to GGP warrants
o Each asset will be examined to extract maximum value
- Master Planned Communities
o 4 communities
 Summerlin
 Is in Las Vegas
 60% of the value of this segment
 7.5 miles away from Las Vegas
 Real property
o 40K homes here, 100K people, 25 schools
o Assets are being sold every day
 The community sells land to developers all the time
 Sold $20M in 2010 for development
 Valuations are the ones he will use to value the
 Bridgeland
 In Houston
 11.4K acres
 More future based development plan
o Operating assets
 South Street Seaport in NYC
 Does generate about $5M in NOI each year
o Held on the books at 1x NOI
 If a 5% CAP rate is used then the value should be
o Poorly run asset that needs attention paid to it
o Redevelopment plan
 Hotels, condos
 Ward Centers
 Waikiki mall
o Strategic development assets
 Not generating cash flow
 Land in New Jersey
 Air rights above a mall in Hawaii
- How do they value it?
o Chairman said it was hard to value it
o Issues
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Long term time horizon

 Manage has said it does not want to flip the properties
 Uncertainty around housing and real state
 Difficult to use traditional valuation metrics
 NOI producing assets appear to be under-earning
 Wide spectrum of possible future outcomes
 Try to create a floor and put numbers around optionality
 Master plan
 Carrying value of $1.3B in total
o Portions of Summerlin have been impaired
o Total range: $1.2B to $2.25B
 No need to sell these assets all at once
 Operating Assets
 Very hard to value
 Each one has NOI
 Certain ones stick out
o Ward Center
 Approval for a new, high end mall and residential
 Has tremendous upside as Hawaii has not seen
the real estate collapse that the rest of the
country saw
o South Street Seaport
 Arrive at a value of $150-$300M
o Landmark Mall in DC
 Arrive at a $200-$400M value
 Strategic development assets
o Fashion Show air rights
 Located on the best part of the strip
 Not going to be build tomorrow
 Over 48 acres in the ideal spot to build a new mega-
 Hard to value it as well
o Conclusion
 Using their valuation techniques, they get a share price from $77 to $141 per
 Attractive risk-reward
 Multiple free options
 Downside protection
 Premier real estate is a great inflation hedge
 Non-recourse leverage
 Catalysts
 Asset land sales
 Development announcements
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Hidden assets uncovered

 Analyst coverage emerging
 Risks
 Double dip in housing
 Time value of money
 Unable to access financing to fund developments
 Execution
- Q&A
o Can you talk about the synthetic option that HHC CEO has?
 Struck in the mid $40s and the CEO put in $15M for that option
 He was not granted this option
 The option is 7 years long and the holders are not allowed to hedge it for the first
6 years
 They believe that the management team checked out the assets on their own and
realized that this was their dream opportunity
 Can make a fortune if they can execute and perform
o How would management develop the properties in general?
 There are different assets that have different timelines
 For Ward Center they have an approved plan
 Each asset will have its own timeline
 South Street Seaport will not be built for a number of years because it
takes a long time to build in NYC
 The answer is that it is property-specific

Day #2

Speaker #1

ValueAct’s Time Horizon Advantage: It’s a Culture Thing

Jeffrey Ubben- ValueAct Capital

- ValueAct is an activist fund

- Manages about $5B and has been managing for 11 years or so
- Mission Statement
o Culture is impossible to measure
o It is hard to perform due diligence on culture
o There is not a more important factor in influencing sustainability of high performance as
firm’s culture
o A wealth of information creates a poverty of attention
 This is why he moved to San Francisco
 Wanted to be away from New York City
 Too much information can actually impair understanding
o Only wants to invest in good business
 He lost money investing in poor businesses before starting ValueAct
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Airlines, retail, commodities, and consumer discretionary stocks

 Has accumulated knowledge through error
 An expert is someone who has made a lot of mistakes in a very narrow
o Under that definition, he is an expert in a very narrow field
o He is not going to stray from his area of expertise
o Everybody in the firm owns the portfolio investment process
 There is always a lead partner on an idea but everyone should touch the idea
o Bad decision happen when the mental debate is cut short
o Farm team investments
 Kind of like a flight simulator
 Real life training ground for investing
 150 farm team ideas have not made it into the portfolio
o Made mistakes in 2007
 Reaching in terms of valuation
 Missed on business quality
 Made top of the market errors
 Hopes that it has made them better
o Money follows passions
 Delayed gratification for long term gain
o In tough times, the team performs the best
 In 2008, they were at their best in terms of handling challenges
 Were singularly focused on investing in one of the richest environments
in a generation
 Tried to stay calm during the stress test in 2008
o Biggest competitive advantage
 The ability to focus on the long term in an industry that has traditionally focused
on the opposite
 Have to match a culture with the investment philosophy
- Ideal ValueAct Businesses
o Profitable, predictable and sustainable
o They like to observe businesses for a while before they become core positions
o Do not short stocks
o Companies that cash flow in good times and bad
 Recurring revenues
 Pricing power
 Small part of customer cost structure but a huge part of the critical path to
 High barriers to entry
 If you buy the number 2 or number 3 player, you want number 1 to have
a high margin and a high PE
o Has to defend the position
 Attractive secular growth
 2x that of GDP
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o >10% FCF growth and yield

o Investment Process
 Start with business quality
 Valuation dislocation
 Governance filter
 Farm team
 Core positions
o Average holding period is about 3 years
- Consistent themes
o Industries in transition
o Companies in transition
 Management missteps
 Will give on poor management because you can change management
 Misunderstood turnarounds
 External dislocations
 Conglomerates shrinking to grow
o Getting smaller to get better
o Governance
 ValueAct does not like to pick fights
 Have only done one proxy in their life
o Was a terrible investment and don’t want to do that again
 Not looking for projects
 Ubben ends up on the board of many of these companies
 Believe that he adds value whether the firm takes board
positions or not
 Isolate execution risk
 Focus on value creating levers
o Important questions
 Do they have the right CEO (have had 18 CEO changes in 60 core investments)
 Transparent, measureable strategic goals
 Compensation structure tied to results
 Detailed knowledge of the business
o Board strategy
 Keep strategy target
 Fact-based decision making process
 Doesn’t accept bad financial models
 Pays CEO for shareholder value, not growth
 Keeps the board honest
 Serves on special committees
 Speaks the truth
 Companies get sold only when it’s the right thing to do
 Sense of urgency
 Companies buy smart and at the right time
 Companies shrink and then recapitalize
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Great sense of the capital markets

 They don’t listen to investment bankers
o Track record
 16 whole company sales
 If they are unwilling to sell, then ValueAct will not go on the board
o Want a upside positions from a takeout premium
 8 big breakups
 4 acquisition growth strategies
o Be contrarian in the M&A cycle
 Buy low and sell high
- Who do they go for the jugular
o When you have a proven CEO
o When nobody else wants to buy
 Capital markets are cold
 Industry is out of favor
 Target company is mismanaged
 Deal is complicated and messy
 Deal fatigue is a problem
 They embrace complexity
- Case Studies
o Valeant Pharmaceutical (VRX)
 Pharma industry is a perfect example of an industry in transition
 1990’s: great run with an attractive industry
o Secular growth blockbusters
o High ROIC
o Intellectual
property: mini
 Early 2000’s: sector hits
the wall
o Growth slows
o Blockbusters go
off patent
o R&D offers
 Overinvestment in therapeutics
o Safety scares
 Mid-Late 2000’s: opportunities created
o ValueAct invested in June 2006
 Tackle the whole backfield in an industry and look for the one who has the ball
 Took an operating approach as opposed to a scientific approach
o Wanted a business model with a predictable revenue stream
 Long tail generics with 1000+ products
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Right company with the wrong CEO

 Got lucky and found the most maverick CEO he has ever seen
 Took an owner-oriented model to the public markets
 Went from 68 countries to only 12
 Went from 2000 SKUs to 1000 SKUs
o Were able to double cash flows despite that
 Philosophy
 Don’t fall in love with your assets
 Don’t bet on science, bet on a management
 Speed is incredibly important
 Invest ahead of the need
 Fact-based decision making

o Willis Group Holdings (WSH)

 Own 7% of the
company and
haven’t sold any
 Low cost
 Outperforms in the
down cycle
 Number 3 player in
the big 3
 Willis,
March &
and Aon
 Has the ability to take share
 An industry turn is available to them
 Premiums to GDP are at a 40 year low
 8 straight years of negative pricing
 A change is likely to occur in the 3-5 years they own the company
 Bought at 9x EPS
 Improved leverage can come from recovering GDP or a hardening market
 Have to be there when the hard market develops
 If you wait, you will miss it
 Stocks double in 6 months

o Motorola Solutions (NYQ)

 Industry overhang
 Concerns over state and local government spending
o Fast twitch traders can’t get past this
 Occupies part of the critical path
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Municipalities do not want to lose a policemen due to radio failure

 Dominant position
 6x the install base of the nearest competitor
o Will see growth through upgrades
 Multiple ways to win
 New product cycle
o LTE broadband
o Video
 Margin improvements
o Spin off
 Industry cycle
 Balance sheet as a
o Cash = 40%
of balance
 Cash on cash retun
 R&D as a percentage of sales
has increased from 8% to 13%
 CEO options have been struck
 The think the CEO gets the problem
 Valuation
 $15B equity cap
 $7.5B in cash
 $2B in debt
 $1.8B pension liability
o Included in EV
 $1.5-1.6B in EBITDA
o Very conservative
o Add back pension attribution
o If rates go up, some pension liabilities shrink
 $200M in CAPEX
- Q&A
o Are they sending pharma companies like Valeant into runoff as opposed to spending on
 They haven’t given up on R&D
 They just partner it off
 Have the same products, they just don’t have the same upside
 Hesitant to invest in new products at high cost
 Given the lack of growth opportunities it can be argued that the company
deserves a low P/E multiple
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 The ability to do accretive deals is crazy

 After buying Biovail, EPS went from $2 to $5
o That’s how much costs can bet cut
o Cephalon deal (they got outbid) would have doubled EPS again,
adjusting for the ramp up in shares as a result of the deals
 Have to keep doing deals though to grow EPS
 This is a rape and pillage situation
 Don’t usually like these situations
o But they have a rape and pillage CEO
 Until management and companies become better at allocating cash, there will be
a lot of accretive deal out there
o Can he talk about how they evaluate CEOs and define if they are doing their job? Can he
also talk about pay?
 Pay is binary: either you are paying too much or not enough
 When they go on a board the CEOs do not say thank God ValueAct is on the
 But, they are supporting the CEO most of the time
o Want him to be successful
 They don’t go in with a strategy to blow up the CEO
 But the company is underperforming so there has to be some change
 Have to get the management to understand accountability
 If they do well they will get a nice equity package and do really well
 But if he doesn’t succeed he is going to be accountable
 They don’t pick the fight if they find a CEO and board that are not willing to be
 Don’t think that any CEOs who left after ValueAct got there would say negative
things about ValueAct
o Question from Whitney Tilson of T2 Partners- Is it true that there is widespread
complacency and mediocrity on boards at a lot of companies?
 Board meetings are very dry and mechanical
 They end up talking about whether or not the company beat consensus
 Mediocrity leads to poor returns for shareholders
o What is the process of taking costs out of R&D in pharma acquisitions? Are the decisions
 Since the Wall Street community focuses on the pipeline and the CEO
internalizes that
 He wants a huge pipeline and doesn’t scrutinize the pipeline decisions
o Wants as many open opportunities as possible
 This is what Wall Street wants to talk about
 You just have to kill projects
o ValueAct is leading Wall Street down a new path
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Analysts had 6 sells on Valeant because Wall Street

hated this strategy
 Management teams who have focused on the pipeline are incapable of
making this change
o Need a new generation of managers
o Question from Whitney Tilson of T2 Partner- What stock is he really excited about?
 Motorola is that company for sure
 Does not like to talk about the farm team stocks because he doesn’t know enough
about them to put money in them

Speaker #2

On Values…
Claude Leveille- Courant Investment Management

- Fundamental principles of investing

o Understanding of risk
o Understanding the right incentives
o Having the right partners
o Temperament
- A more rational approach to risk
o When price goes down, risk does not go up—margin of safety goes up
o Risk is the probability of losing one’s capital
o Understanding risk is the first step to becoming a great investor
o Does not short stocks
- Temperament
o Rationality is critical
- Incentives
o Incentives are powerful and have a deep psychological impact
o The typical 2/20 fee structure of hedge funds grossly misaligns interests
o His fee structure is more like the one from Buffett’s partnership
 75bps management fee
 15% over a 5% hurdle rate in order to receive a performance fee
 97% of his own is wealth is invested alongside
 100% of performance fees remain in the fund
 No gates or side pockets
 Investors have 30 days to get out, at will
- Partners/Investors
o The psychological pressure from having the wrong partners can not only make life
intolerable, but also lead to flawed decision making
o Most of his partners are friends of his
 6 of them are guys who have sold businesses to Google
 Very rational people
 Share the same philosophy
 He feels a moral duty to his partners
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 He thinks about bringing on new partners like Buffett thinks about issuing
Berkshire stock
 Better to not dilute the quality of the current group
 BP plc (BP) was an early test
 Thought it was a great investment after the oil spill
 Was initially worried about the liberal bend of his partners
o Thought they might not like to see that he was investing in BP
 He then invested 10% of the partnerships in BP stock
 His investors then wanted to by BP shares themselves when they found
out he was buying
o Thinking rationally in investing
 Favorite biases
 Wishful thinking
 Confirmation bias
 Herd instinct
 Self-serving bias
 Incentive-cause bias
 Over-influence of authority
- Investment process
o Pay a lot of attention to the price paid
o Stay within a circle of competence
o Eliminate a lot of stock right off the bat if:
 The business is not understandable
 There is no rule of law in the geography
 Economics are driven by commodity prices
 The company operates in a technological area in which the rate of change is very
o Winnow down the portfolio to about 10-12 stocks
o Analyze the business and not the stock
 Doesn’t worry about P/E ratio or 52 week high/low
o Look for critical issues that will drive yes/no for the investment decision
 Time is a constraint
o Use a checklist to make sure he doesn’t miss anything
 Questions
 Does he understand the business?
 Is there a solid moat?
 Does management control the economics?
 How long is the history of the economics and the current ROE?
- Track record
o Has compounded at 7.4% since 2001
o Was only down 9% in 2008 when the S&P was down 37%
 What was he doing before the crisis?
 Sitting on his hands
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Not acting is acting

o While the real estate bubble was building, he was building cash
 He was impervious to lagging S&P be several percentage points
o What did he do in 2009?
 In 3-4 months he shifted the entire portfolio
 Went from cash and TIPS to stocks being and fully invested
o Companies bought: Prologis, White Mountain, and other
property and casualty (P&C) insurer
o Bought investment grade corporate bonds
 He was 70% invested in deeply discounted bonds
o The best investments are the simplest to understand
 Prologis (PLD) bonds
 Largest US industrial warehouse REIT
 $20B in assets, $12B in debt, $8B in equity
o Debt was trading at 50% of par
 The implied price effectively valued the real estate at less than 35% of
 Simple tools
 He had no need for advanced formulas, financial projections or anything
of the sort
 Spirit Aerosystems (SPR)
 The stock was trading at 75% of TBV and at 4x earnings
o Company had little debt
 Long term exclusive fuselage and wing contract with Boeing
o Monopolistic-like contract
 He knew that the financial crisis would not cause civil aviation to
- Common Mistakes
o Selling too early
 Solid investments are very rare
 Sometimes is it best to let them compound at a high rate
o Not concentrating positions even more
o Going outside of the circle of competence
 Recent investment in Hong Kong is an example
 Investing in China and Hong Kong requires on the ground knowledge
 However, he does like investing South Korea and Singapore and thinks
he understands those countries
o Holding too much cash
 Macroeconomic noise is almost always a distraction to be ignored
 Has 25% in cash right now
- What is he not investing in in now?
o Bonds
 Owns no bonds
 All of his positions have been liquidated because prices are up so much
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o US Treasuries
o Gold
 Very weary on inflation but believes gold is a red herring
o Euro
 People are going for slightly more yield standing and risking that a number of
countries could try to leave the euro
 Purchasing power parity (PPP) with the dollar is about 1.10 and is trading at
about 1.43
- What is he buying
o South Korean equities
 A few sound companies with high ROEs, families as majority the majority
shareholder, and long term shareholders
 Average valuation and returns
 1x TBV, 6-7x EPS, 15%+ ROE
 Food products and retail
 Thinks that the won is discounted 25% based on PPP
 Thinks the country represents a phenomenal story
 15%-20% of his portfolio is in South Korean equities
o Bermuda P&C insures
 P&C market is very soft
 Is buying these companies at $.65 on the dollar
 Looks at it them like corporate bonds
o US large cap stocks
 He likes healthcare companies specifically
 Companies that have amazing franchises and high ROE selling are at 9-
11x earnings
 These businesses are not going anywhere
 These low multiples haven’t been seen 10 or 15+ years
 Intends to hold the shares for a long time
o Is still keeping about 25% in cash
 Wants to be able to respond to new opportunities
- Q&A
o He says his core skill set is protecting capital. But yet, he investing in BP. Is he
overstating how much he is a value investor?
 Referring to the BP investment ---which does not look like its fits his investment
strategy—he thought the market had overreacted
 It is important to protect capital in bad years
 There is a huge difference between multiplying by zero and protecting wealth
 Thinks he can protect capital and generate high returns
 The idea that higher risk leads to higher returns is insane
 He likes defensible businesses that he can get at a great price
o What is he doing to protect against inflation?
 It is very difficult to protect against inflation
 He is buying really good businesses with high ROEs
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Even if inflation is high, these companies should be able to raise prices

 Companies that will not need to deploy new capital (CAPEX) at inflated
 TIPS have had negative yields so those doesn’t make sense
 Having cash or defensible businesses is the answer
 In general, he doesn’t like resource companies because there is no way to predict
the price of commodities
 He is weary of investing in business in which the profitability has to do
with the price of a commodity
 Will invest in resource companies such as BP opportunistically but not
for the long term
 Does not think resource stocks can protect investors against inflation
o What Bermuda reinsurers does he like?
 Aspen Insurance Holdings (AHL) and Axis Capital Holdings (AXS) are the ones
he likes
o Question from Luis Ahumada- Can he talk about how he decides how much cash to hold?
 Does not pay attention to the macro side of investing
 Said we should tune out all of the media’s focus on the macro-economy
 He used an example of all of the useless discussion of whether the US
will experience a double dip recession
o Looks at the prices of the security far more than he does
anything else
o How does he have an edge in South Korea?
 Country has a much better rule of law and property right than others
 Enforceability of contracts is present
 Invests in very simple businesses
 No debt, no leverage
 Long track records of very sound numbers
o How did he determine to deploy cash in 2009?
 He started doing so in late 2008
 Thought the times were amazing on terms of deploying capital at great
 Invested gradually
 Knew something great was happening
o But there was too much to buy
o He was working 20 hours a day trying to decide what to buy
 He decided that he was going to focus on corporate bonds and few stocks
in which nothing bad could really happen
o Thought a real collapse was unlikely but possible
o The bonds did limit his upside but he was sleeping very well at
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

Speaker #3

A Treasure Chest Beneath a House of Cards?

Michael Kao- Akanthos Capital Management

- Set up Akanthos in 2002

o Akanthos is a capital structure long/short hedge fund
- He is a value investor across multiple dimensions
o Equity, credit and volatility
 Convertible arbitrage, capital structure arbitrage, event driven strategies
o He seeks a margin of safety across the capital structure
- Wants to be long optionality as opposed to short optionality
- Layers in a portfolio with a lot of asymmetric payoffs
o A lot of good things can happen
- Looks for latent and explicit catalysts
- In between high concentration and a lot of diversification
o Feels the need to be thematically diversified
 Trumps all other types of diversification
 Perpetuity option
o An opportunity with an asymmetric payoff of a speculation that
can be analyzed like an investment
 An option with no imminent expiration date
 Example: railroad bonds in the 1930s
 Nationalization fears and government
intervention produced a generational opportunity
in railroad bonds
 2008 produced multiple ―Railroad Bond‖
opportunities in convertibles
- The Ultimate Railroad Bonds
o GSE--Fannie (FNM) and Freddie (FRE)-- Preferreds
 Started off as a short idea as these securities were yielding 7-8% in 2007 and they
didn’t think that yield compensated investors for the risk in the housing markets
and economy
 Went down to 1.5 cents on a dollar
 Now are 6-7 cents
 GSE capital structure was a house of cards
 Huge amounts of debt and a thin layer of equity capitalization
 Extra thin layers of subordinated debt and preferreds
 There were many factors to blame in the housing crisis, not just the GSEs
 GSE’s were placed into conservatorship
 Guaranteed the senior debt and subordinated debt
o Wiped out the dividends on the preferreds arbitrarily
 Paulson said that everything above the preferred line got
par and everyone else got nothing
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 US Treasury has put in $155B into the firms and now have a senior
preferred that pays a 10% dividend
 Community banks were huge holders of the preferreds
 $2.6B of preferreds issued in 2008 did not even pay a dividend before
97% of value was wiped out
 Regulators actually encouraged banks to buy these preferreds to protect
against losses
o Were considered part of core capital
 The preferred market was the last bastion of capital for banks and after the
conservatorship, the entire preferred market fell apart
o Misconceptions about the GSEs
 They must be abolished
 Full nationalization or privatization are the only answers
 They are black holes
 They caused the financial crisis
 They cannot be fixed
 GSEs are generating record net interest margins
 10% dividend on government preferred is unduly punitive
o TARP banks only paid 5%
o Thinks that if the GSEs were 100% privatized, rates would go up so much that the
housing market would be destroyed
 But $6 trillion would be added to national debt if they got 100% nationalized
 So, we are basically stuck
o Investment thesis
 A public-private compromise is necessary
 The GSEs can recapitalize themselves over time
 A privatized structure with a reinsurance program structured behind private
capital is an attractive option
 Treasury is leaning towards a modified status quo
o What has the Treasury been discussing and doing?
 Reducing the market share to 40% in 5-7 years
 Raising prices on GSE guarantees
 If they do not take extreme actions, the optionality in the preferreds remains and
extends out to perpetuity
 The government preferred is preventing the company from recapitalization
 All are reportable losses are from the government dividend
 They are drawing down more money from the Treasury to pay the
dividend on the preferred
o That is just crazy
o Are they well enough reserved?
 Net charge offs have been less than their provisions
 Total realized losses are less than their reserves
 FHFA estimates of how much loss the GSEs would require—how much they
would draw down from the Treasury— have been much higher than actual losses
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Suggested recap #1
 Cut senior preferred dividend to 5%
 Restore publicly traded preferred dividend
 Would cost less than $3B per year combined
 Would reopen the doors to letting the public markets back in
 Would restore the capital in regional banks
 Where could the preferreds trade?
o If they traded at a 10% yield, the preferreds could trade 80-90
o Suggested recap #2
 Equitize the senior preferred and publicly traded preferreds as pari passu
 Where could these trade in this scenario?
 Base case 1: all serious delinquencies default
 Base case 2: based on cumulative default curves provided by the
 Bad case: All high LTV loans default
o Only case in which they are not adequately reserved
 What could Akanthos make?
 Assuming 40-50% market share
 Not expected to pay net income taxes for a long time
 Earnings power:
o Fannie: about $15B per year
o Freddie: about $13B per year
 If you add 8-10x multiples
 90% to 160% upside
o Risks
 Political
 Principle reduction
 Nationalization
 Forced wind down
 Market
 Decline in housing prices
 Interest rate or credit shock
 Idiosyncratic risks
 Accounting risks
 Derivative mis-hedging
o Summary
 Extreme solutions of 100% nationalization or privatization are not likely
 Modified status quo and a regulated public/private model is the best solution
 A recapitalized, tightly run Fannie and Freddie could become very profitable
- Q&A
o What CUSIP are they advocating?
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 These trade like penny stocks because they are delisted

 Even though there was $35B issued, these are incredibly illiquid
 Ticker: FNMFO
 Trading around $6500 with a par of $100,000
o How are the preferreds represented? Is there a credit committee?
 In every large Chapter 11 or reorganization there has been a group of heavily
organized creditors
 But there is not a large voice in this case
 Conspiracy theories
o Buyers were the banks and insurance companies
 Banks are now owned by the FDIC so there is no voice
 You can wield a lot of power with a small bond ownership stake
o Akanthos has been trying to round up other owners of the
 Found only $2B of the $35B being held at hedge funds
 Who owns the other $33B?
 The community bank lobby has been writing to Congress suggesting a
plan similar to what Akanthos is suggesting
o Does he have different default assumptions for Fannie versus Freddie? Are the portfolios
 The assumptions are based on what was available to them from the companies
 Took the assumptions from the companies
 Freddie may have a better book in the guarantee book
 Does not change the thesis though
o What size bet would you put on for a position like this?
 Will size highest conviction ideas to lose no more than 3% in the worst case
 When the price goes up, it becomes a larger percentage of their capital
 To control mark to market risk, they try to establish trailing stops on their
 This position inflated to a 10-12% position after the price went up
o Thesis hasn’t changed as the shares have gone from $.02 to
$.065 though
o Can you talk about the commitment fee waiver?
 So far the commitment fee has been waved and it looks like it was put in there as
a catchall in case the government wanted to punish the GSEs
 The best case scenario is if the tax payers get their money back and private
capital replaces the government’s capital
 Turn the GSEs into a regulated utility
o Question from Ryan Morris of Meson Capital- Would the government actually allow pari
passu securities to be created if the preferreds were equitized?
 The government made decisions to arbitrarily hurt the creditors of Chrysler’s
bonds because the base was made up by hedge fund and TARP banks
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Nobody likes TARP banks and hedge funds and thus they received less
favorable treatment
 The government would not and could hurt the mom and pop retail
investors on GM debt
 Thinks a similar situation could play out here as some major holders of
GSE preferreds are community banks
o Can you share other themes they are investing based on?
 The inflation issue worries him quite a bit
 Thinks in option-like payoffs
o Gold, farmland and real estate have already left the station
 He doesn’t even know how to value gold
 These assets are already full priced
 The Hong Kong dollar is the only fully convertible and liquid currency that is
hard pegged to the dollar
 His suggestion is to open up an account at an HSBC bank and buy Hong
Kong dollars
 You can earn zero here or zero there—so you might as well hold Hong
Kong dollars
o Hong Kong and China have major asset inflation and they are
letting Bernanke run their momentary policy
 As such, they are likely to de-peg and the Honk Kong
dollars could really appreciate
 This is a very asymmetric bet
o Could the GSE equity sliver be worth anything?
 In a rosy scenario is yes
 But remember how much capital is on top of that equity
 Combined market cap right now is around $8B
 Total value of preferred right now are only $2B
o Even though they are higher up in the capital structure
 Would be short the equity versus the preferreds
 Does not make any sense

Speaker #4

Americans Abroad: The Cautious Adventures of US Value Investors

Jonathan Friedland- Porter Orlin

- The firm is made of stock pickers and has $1.3B under management
- Almost everybody in the research department is partner in the firm
- Has had low correlation with other hedge funds
- Are always looking for value with optionality
- How did they start investing globally?
o Started investing globally in 2002
o Investment management industry was moving in this direction
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o Paired EDS/ Indian Outsourcing

o Distressed debt opportunities in 2002
o US may not be the most stable, safest market in the world
 What do you do when risk free has a negative outlook?
o Development of global effort
 Adapted core principles
 Found great businesses in highly concentrated industries
 Slowly developed competencies, relationship and knowledge
 Internal database
 Have created a database of great companies and great managements for
which the shares many not be appropriate but at that time but that they
want to keep track of
o When prices fall and valuation become more attractive, they are
then in position to buy
 Emerging market (EM) companies have better balance sheets and less leverage
 Think that EM countries will have better growth going forward
 Think portfolio companies can achieve growth better than the rate of
GDP growth
 Dependency ratios are much lower than in developed markets
o Consumers will spend on consumer goods and not medical care
as in the west
 Risk
o Portfolio management at the asset class level
 Markets move as a class at times
 They look at where stocks are trading relative to their
histories, other countries and developed markets
o Look at the country level for certain criteria
 Big domestic population
 Strong balance sheet
 Stable and predictable economy
 Dependent on global growth or internally driven?
 Imports and exports to GDP ratios
o Company level
 Great companies
 Great franchises
 Great management
 Optionality in the shares
 High barriers to entry
 Strong balance sheet
 Predictable and recurring revenues
 Generally misunderstood assets or prospects
 Open ended growth opportunities
o Very active in hedging
 Do not engage in lots of shorting
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Shorting is tough in emerging markets

 Try to buy derivatives with defined downside and lots of
upside if we get big hiccups
 There is not a good infrastructure for hedging in
these markets
 Strategy is to buy the long term investment case and
hedge hiccups that can cause speed bumps

- Raia SA of Brazil (Sao Paolo

Exchange: RAIA3)
o Drugstore operator in
o Secular growth and
o $1B market cap
o Strong balance sheet
 $250M in net
o Income growth will lead to increased spending on drugs
o Increased sales of HPC and generics
 Brazil has a similar generics cycle to the one in the US
o Pharma and HPC markets are both growing by 10%+ annually
o Are comfortable with the management team
 Company was founded 100 years ago
 CEO has been there for 30 years
 CFO is former CFO of Natura Cosmeticos
 Insiders and sponsors own over 50% of the stock
 Pragma family owns 10% of stock
 Investment firm Gavea owns 6%
o Nova Mercado Listing
 Strong protection of minority shareholder rights on this exchange
o Secular shift to organized drugstore format benefits Raia
 Improved tax collections
 The tax evasion advantage that moms and pops had is gone
 Economies of scale
 Removing the cost advantages of informal operators
 Chains are about 20-25% of pharma sales in the Brazil and over 50% in the US
o Unit economics of new stores is very attractive
 32% ROIC
o Disciplined competitive environment
 5 major chains
 Expansion looks like it is taking consolidation in mind
 Companies are building new stores in different areas to avoid overlap
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

 Have 30-40% cost advantage over moms and pops

o 25% CAGR for generics
 Gross profit is 2.5-3x the branded gross profit
o Has seen top line growth of 20%+, same store sales growth, and 10-15% growth in new
o Valuation
 8.5x forward EBITDA
 Think that CF can grow at 25%
o Think about this company like Walgreen’s in its consolidation phase

- Television Broadcasts LTD (Hong Kong Exchange: 0511)

o Dominant franchise
 Competitor has been through a number of management changes
 Market share has been growing
o Strong balance sheet
 15% of the market cap is net cash
o Only derives 4% revenue
from China
o Important shareholder
change occurred
o TV’s share of advertising is
growing, despite the
o Very popular in Mainland
 Cantonese is
spoken in HK and
Guan Dong, the
closest province to
Hong Kong
 Have some of the top dramas in China
o Valuation
 The market is not placing much value to the China opportunity
 Pays a 4% dividend yield
 Stock is trading at about 11x EPS based on 2011 numbers, net of cash
o Catalysts
 Consortium purchased 30% stake from the 104 year old founder
 Providence Equity joined the board
o Jonathan Nelson (the CEO) himself is on this board
 Has great experience in China
 Big investor in Baidu originally
 Co-founder of HTC
 Chairman of ITC Corporation
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

- Coal India (National Stock Exchange of India: COAL)

o IPO that came in the last year
o Represents the best characteristics of
both a growth opportunity and a
o Has a $45B market cap
o Largest coal reserves and production
on the planet
o India has a huge power shortage
 Cannot get enough coal in
 Country has to
import coal
 Most of India’s electricity comes from coal
o Company has hit 95% of its production targets for the last 10 years
o 90% owned by the Indian government
 However, the engineers are in control
 Have reduced employees by 100K over the past 5 years
 This firm is not a government job bank
o Sells coal in the Indian market at about ½ the level of import prices
 Has pricing power and ability to raise prices
o Firm is a low cost producer
 Importer cannot have a lower cost base
 Open cast mine in India
 Apparently the coal is sitting on the ground
o This company is incredibly lucky to have these resourced
o New market opportunities
 eAuctions
 Could get to 20% share
 Washed coal
 Opportunity to create cleaner, higher quality coal
o The company has to be 25% owned by the market in the next few years
 The government will have to sell more shares
o Valuation
 Expenses are growing less than revenues due to revenue attrition of 4% per year
 Trading at about 12x calendar 2012 EPS
 Earnings are under-reported
 Company is forced to reduce EPS because of excess amortization that is
disallowed by IFRS--which is coming to India
 10.4x P/E multiple excluding excess amortization and net cash
 Comparable national champions trade around 15x EPS
- Q&A
Ben Claremon: The Inoculated Investor http://inoculatedinvestor.blogspot.com/

o The slides mentioned that the firm owns shares of Sanofi Aventis (SNY), is that really a
great company? Also, headlines say that Coal India is raising prices to pay higher wages.
What do they think of that?
 Sanofi has a significant position in the industry and he thinks there is a lot of
value there
 Market is overlooking long term earnings power just because of a few
down years
 Has more recurring revenue than other pharma companies
o Trading at 7-8x earnings despite that
 It is true that Coal India has been paying higher wages
 However, with the company’s low cost coal, there is some room there for
higher wages
o Coal India has had a number of negative headlines? What do you make of those?
 All expansion plans were halted right after the IPO by an environmental regulator
 In general, they do not think that the government and regulators could
stop expansion because India has a power shortage
 If they shut down India Coal’s expansion then India would have to
import expensive coal
 Big wage hikes come with high price hikes
o Do they look at relative valuations between Brazilian drug store companies?
 They think the one they own can grow the store base faster
 They don’t look at relative valuations although they thought it was cheaper than
the competitors
o How do they get comfortable investing all over emerging markets, especially off the
beaten path ones?
 Some people used to shut down when they heard that investment managers
wanted to invest in Vietnam
 Were lucky to start investing when valuations were very low
 Have developed a competence little by little since then
 Got comfortable slowly and carefully