Value Investing Congress Blog

The 3rd annual Value Investing Congress West kicked off today with an introduction from co-founder John L. Schwartz, MD. Each presenter discussed their investment philosophy, addressed current market issues, and then highlighted specific investment ideas.

First up were Mark Sellers and Victor Fasciani from Sellers Capital LLC, whose Sellers Capital Fund has booked an impressive 36% annualized (net of fess) since inception. Seller’s runs a highly concentrated portfolio of companies with what they believe to be “wide moats”.

Sellers and Fasciani presented the case for Vulcan Materials (VMC, $66):
• Demand for aggregate materials (asphalt related) will grow as US infrastructure (bridges, roads, etc) are in need of repair.
• The aggregate industry suffers from the “Not in my back yard” syndrome, so new mines are not being opened quickly enough. Plus, it takes five years, an onerous amount of permits, and $100 million to open a new mine.
• With growing demand for aggregate material, and desperate needs for infrastructure improvements in the US, Vulcan is well positioned to be a beneficiary.
• Sellers and Fasciani believe the stock is worth at least $90.

Next up was Jeff Bronchick from Reed Conner & Birdwell, LLC. Bronchick seems never afraid to speak his mind, which makes him a very entertaining speaker. Among other things, Bronchick brought forth the notion that value investing is far from an exact science, and while it is successful over time, it does not work in every time period. On the subject of the credit crisis, Bronchick suggested that the situation may not be as dire as it appears, and took aim at industry execs that still have their jobs despite terrible mismanagement.

Bronchick’s main focus was AIG:
• Company is unfairly tarnished, and has been punished by headline risk
• Has never been cheaper at 8 times “depressed” earnings
• Has $13 billion in excess capital
• Potential write-offs are very small given the company’s large asset base
• Company has plenty of staying power

Bronchick also addressed GE, suggesting that management needs to, among other things, drop quarterly guidance, stop selling businesses at book value, then paying dearly for other businesses, and buy back stock and/ or increase the dividend.

Jonathan M. Heller, CFA
*Author does not own any securities mentioned

I’m back in Southern California for my second Value Investing Congress West (May 6th and & 7th), and this year I’m also attending the Pre-Congress Workshop, An Advanced Seminar on Value Investing, taught by T2 Partners’ Whitney Tilson and Glen Tongue.

As a CFA Charterholder with an MBA, a small financial advisory practice, and 20 years in the business, I’ve been in my share of classrooms over the years.

Tilson and Tongue’s detailed, fast moving, but equally understandable instruction style make this pre-Value Investing Congress session well worth attending.

Morning Highlights McDonald’s
An excellent case study on the fate of McDonald’s (MCD) following the company’s 2003 bottom opened today’s session. Tongue recounted a previous analysis of the company which argues against viewing McDonald’s as merely a quick service restaurant company, preferring to characterize it as a Brand business (including real estate and franchises) and a restaurant company with more than 8000 company owned stores. This is the way that we, as value investors, are trained to think. A little reinforcement here is never a bad thing.

The restaurant business is much more complicated than one might think, and Tongue and Tilson’s insights on the industry as whole, and a few of the players, were extremely valuable.

Berkshire Hathaway
Tilson and Tongue are still unapologetic Berkshire proponents, and put the current intrinsic value of the A shares at nearly $180,000 per share, a 40% premium to the current price. (Interestingly enough, the audience at today’s session was polled, and at least half were at last week’s Berkshire annual meeting!)

The Mortgage Crisis
For his part, Tilson believes that we have not yet seen the worst of the mortgage crisis. His extremely detailed presentation (“An Overview of the Mortgage Crisis and the Structure of CDO’s”) paints a very bleak picture, suggesting that all things housing and mortgage related will get much worse before improving. Tongue and Tilson put their money where their mouth is with short positions in monoline insurers AMBAC and MBIA, and a long position in Fairfax Holdings (which has gained and may gain further in the mortgage crisis due to its credit default swap holdings).

Jonathan M. Heller, CFA

A Diamond in the Rough? by Bill Vlahos

Communicate.com is a completely undiscovered e-commerce company whose assets are conservatively worth 50% more than the current market cap (and might be worth much more over the next 2-3 years).  Given the size of the opportunities on the company’s plate, the talented new management team which has a proven track record for execution in the space, and the value of its assets we feel that it is currently the best risk/reward idea we own.

Communicate.com is under the conventional Wall Street radar screen, as the company is in Canada (even worse, it’s in Vancouver!) and currently trades on the Canadian bulletin boards.  As management is starting to execute we believe now is the optimal time to own the stock, before it is discovered, as it won’t be a secret much longer.  The company has applied for an AMEX listing with intentions of ultimately moving to the NASDAQ.  They have hired an IR firm to begin to tell their story starting in January.  We believe they are also on the radar screen of some analysts who specialize in the space.  Also, the company has an unannounced name change which will better describe it and hopefully resonate well with the investment community.

The market for valuable domain properties continues to be very strong, as seen by recent transactions.

Business.com - $350mm (acquired 2007)
Ancestry.com - $300mm (majority interest acquired 2007)
Howstuffworks.com - $250mm (acquired 2007)
Dictionary.com - $100mm (acquired 2007)

In sum, Communicate.com is an Internet retailer which owns over 1100 domain sites.  We believe that about 30 of them are valuable; although with the recent strength of the domain resale market we are starting to believe some of the smaller domains may have some economic value as well.  The crown jewels are Perfume.com, Cricket.com and a collection of six international sites (including Brazil.com and Vietnam.com).  We believe that these three unique verticals could represent a $150mm revenue opportunity for the company over the next 3 years.

We view the portfolio assets of CMNN as follows:

Pefume.com                $20mm       Two times ‘07 revs, should be up sharply in ‘08
Cricket.com                $6mm         Recently rejected a $6mm offer according to Mgt.
Six Travel sites           $25mm       Scotland.com was bid/Vancouver.com sold $3mm
Balance portfolio        $10mm       Includes boxing.com, importers.com, body.com, etc
Cash                            $7mm

Total    $68mm

The only site that is currently being operated is Perfume.com.   The old management didn’t put too much effort into the site, as there was no banner advertising, affiliate programs or even email to existing customers to spur renewed sales.  However, the site still managed to generate $10mm in revs last year.  With some blocking and tackling it should be relatively easy to improve revenues and gross margins.  The company hasn’t said much about the other sites–some will simply be licensed (perhaps Boxing.com) and some of the non-core ones will be sold.

In small caps management is always key.  The new CEO, Geoff Hampson, is very impressive (the previous CEO and founder decided to step aside and hire the most qualified person to build out the company to its full capacity).  Immediately upon being hired Hampson bought $1mm of stock at a slight discount to the market.

Geoff Hampson built Peer 1 Network Enterprises, an Internet infrastructure company from almost nothing to a $150mm market cap company.    He has already assembled a strong management team including Jonathan Ehrlich who is the company President and Chief Operating Officer.  Ehrlich was most recently Executive Vice President at Indigo Books and Music.  He was widely credited with being one of the main drivers in Indigo becoming the largest Canadian seller of books and music online.  All of the executives participated in the recent equity transaction buying stock at $2 with no warrants-all interests are aligned.

Communicate.com represents a unique opportunity to own a completely undiscovered growth company at a substantial discount to its assets.  A multi-bagger from here is possible if management executes well — if they don’t they should be able to liquidate the company for 50% more than the current market cap.

Bill Vlahos is the portfolio manager at Odyssey Value Partners in San Francisco.

Another “Friendly” Deal?

by Phillip Ristau

Steak N Shake (SNS) has 28,469,808 shares outstanding. The shares trade near a 52-week and multi-year (April 2003) low . On the most recent conference call, management acknowledged, “we have not been field focused for several years.”

Why would anyone invest in SNS? There may be a catalyst. There is a proxy fight to gain two board seats by tenacious value investor Sardar Biglari. A sale of Friendly Ice Cream was announced about 9 months after he disclosed his initial 13D filing in 2006 for about twice his average cost.

SNS owns about 155 of its properties. In 2001, it averaged about $1.1 million for 14 sale/leaseback transactions. Assuming $1.1 million x 155 properties equals $170 million or about $5.97 a share. In addition to selling the real estate at its company-owned stores, SNS could sell the stores themselves to franchisees to generate even more cash – this move is an important objective of Biglari. One goal (of many) of Biglari’s is for the company to refranchise its company-operated restaurants. Applebee’s and Denny’s received about $1 million per refranchised unit. SNS operates 435 restaurants, so if each restaurant is worth $1million, that is another $435 million ($15 a share) .

For 2006, SNS had 48 franchised restaurants and earned $3.88 million, or $80,854 per franchised-unit. SNS plans to open 9 company restaurants and 6 franchised restaurants in 2008. It will probably take 2-3 years to refranchise all 435 restaurants. Assuming franchise units grow 15 per year, that is a total of 536 franchised-units at the end of 2010. 536 units @ $81,000 is about $43 million in revenues. A pure franchise model should yield at least 15% operating margins. Operating income should approximate $6.5 million pre-tax. A pre-tax multiple of 12 (reasonable for a business with relatively high operating margins and very little in capex) gives us $78 million or $2.73 a share.

Putting it all together, SNS’s earnings are worth $78 million in three years, discounted at 10% equals $59 million or $2.06 present value per share for the pure-franchise model. In addition, a sale/leaseback plan for the real estate would generate $5.97 a share for the 155 properties it owns. Finally, refranchising 435 units might generate $435 million, or $15 per share. Since this operation would take time, I use a 10% discount rate and a three year time frame. I derive a present value of refranchising of $327 million, or $11.47 per share.

Thus, intrinsic value is $2.06 future earnings + $5.97 sale/leaseback proceeds + $11.47 refranchising cash for a total intrinsic value of $19.50 per share. SNS is currently trading around $11.

Full disclosure–the author has a position in SNS.

Mr. Ristau is a value investor in Texas.

On Seeking Professional Help

By Dan Ferris

There’s much documentation to show that most investors – individual and professional alike – fail to adequately appreciate how difficult, and therefore rare, is the production of outsized investment returns.   I don’t want to suggest that you’re crazy to pursue such a goal, but I think most of us – again, individual and professional alike – ought to have no qualms about seeking, as it were, “professional help.”    

Seeking professional help means that, when the public equity markets offer you easy access to a great capital allocator, you should exploit the opportunity.   The names I’m talking about include the folks in Omaha, Loews, Sears Holdings, Leucadia National, Markel, Fairfax Financial Holdings and the one I own, for which I shall advocate forthwith, Alleghany Corporation (NYSE: Y).    

Aside from its well-covered large, successful bets on Burlington Northern and perhaps a dozen big cap energy stocks, Alleghany most recently found a sweet spot in its principal operating business, property and casualty insurance.   Unlike the rest of the property/casualty market right now, pricing in the California workers comp insurance is firming up.  Premiums soared earlier in the decade.   Employers screamed bloody murder.  The state passed sweeping reforms, and premiums fell 60% from 2003 – 2007.    

Today, it’s hard to get a rate cut without a stellar claims record.  One employer that saw a 46% reduction on its 2006 renewal, reports a 9% increase in 2007.   The California Workers’ Compensation Insurance Rating Bureau, a non-profit that tracks claims data, which recommended a double-digit cut last year, recommends a 4.2% increase in workers comp premiums this year.   

Right on cue, in July, Alleghany bought Employers Direct Corporation, one of the top 20 workers comp insurers in California, for $192.5 million.   Capital allocation certainly isn’t about calling insurance market bottoms.  Then again, happy accidents tend to happen to good professional helpers.    

Alleghany can be had today by paying $1 for each $1 of net assets, and 35 cents for all the future earnings and investment gains of chairman John Burns, CEO Weston Hicks, and their future successors.   The price doesn’t discount much certainty that Alleghany will find conservative enough investments that will achieve high enough returns over the long term.   I’m betting it will find them.  It is arguably the cheapest, and not likely the riskiest, of the professional helpers: 

Professional help on sale (multiples of book value)
 

Alleghany’s $4.7 billion of investments (and $3.2 billion market cap) doesn’t have the “bigness” problem they have in Omaha.   And Alleghany will certainly approach its larger pool of choices with its time-honored conservative, risk-averse posture.  The odds are squarely against similar treatment of our capital by most fund managers, whose results look like quackery next to those of our professional helper list.  

Yet, too many people persist in the conviction that they’ll make big returns (which is necessarily born of something other than experience).   This is expensive lunacy, however common a form.  I contend that easy access to good professional help tends to be undervalued at any given moment.  Consider the trillions in mutual and hedge funds doomed never to outperform.  If those investors ever got even a little bit wise, the above list, at a total market cap of $269 billion, is such a tiny drop in the bucket that the list could find itself trading at lofty multiples as lousy returns persist, which they will for the vast majority of market participants.  

 I suspect many stock market participants who felt sane last year feel crazy right now.   Next year and beyond, then, quality professional help might well command a premium price. 

 -Dan Ferris

Ferris Capital Management, LLC is an Oregon registered investment adviser www.ferriscapital.com

FULL DISCLOSURE:  I own or have trading authority over shares of Alleghany.   This should not be construed as an offer to buy or sell securities.