Jason Stock and William Waller, M3 Funds
Banks & Thrifts: Opportunities in a Troubled Sector

M3 was founded in 2007, and invests (long and short) in small and mid cap names in the US bank and thrift sector. There are 1300 publicly traded banks, and 93% have market caps less than $500 million. Stock presented his view of the current state of the banking sector:

• Banks still undercapitalized
• Credit quality still deteriorating
• More bank failures
• Unemployment rate will continue to rise
• Commercial real estate is in trouble

The team is bearish overall on the sector, believing that banks are currently priced for perfection. Still, he and Waller are finding opportunity on the long side, and look for the following:

• Low Price/Tangible Book
• Excess capital
• Low loan/deposits
• Attractive markets
• Bearish management team
• Share repurchase plan
• Attractive deposit base

One of their favorite long ideas:
Beneficial Mutual Bancorp (BNCL)

• $4.2 billion in assets
• Oldest/largest bank in Philly
• Excess capital
• Owns 42 of 68 branches
• Mutual holding company structure has benefits
• Trading at 79% “fully converted book value”

Kian Ghazi, Hawkshaw Capital Management
Kicking the Tires

Ghazi, who runs a concentrated long/short US equity portfolio, emphasizes proprietary, investigative research in his investment process:

• Focuses on value
• Identifies high-quality one-of- a-kind franchises
• Ensures financial strength, have excess cash, strong balance sheet, and monetizable assets
• “Kick the Tires Hard”- know what you own
• Asks: “What could cause stock to drop 30% or more, that would cause you to not want to buy substantially more?”

Ghazi presented the case for Coremark (CORE)

• Second largest distributor to convenience stores
• $300 million market cap
• $30 million net debt
• Trading at 12 times est 2009 earnings, 8 times TTM earnings
• Admits that this is a low margin business with low ROC, but is well capitalized, difficult to replace, underfollowed
• Highly fragmented industry
• Cigarette sales account for 70% of revenue, but just 29% of gross profit
• Company moving toward providing more fresh foods, which have much higher margins. This should more than supplant potentially declining cigarette sales.
• Believes company may ultimately be worth $45-$50

Eric Sprott, CEO Sprott Asset Management
The Financial Crisis Isn’t Over

Sprott began by pointing out that Dow 10,000 is meaningless; we were there 10 years ago, and since then, have “accomplished nothing”. He is highly skeptical of the US banking industry, and predicts many more bank failures in the days ahead.

Sprott also took shots at the “Quantitative Easing” process being used at the Fed these days, likening it to the very dangerous practice of simply printing more money. He questioned who is buying all of the US govt debt, with issuance up 200% this year, and concluded that it’s the central banks doing all of the buying. Sprott then asked the most relevant question: “What happens when quantitative easing is done?”

Sprott believes that gold is a relevant place to invest these days, pointing out a sticky supply/demand situation, fact that more demand is consumed than produced each year, central banks have been selling as the price has risen substantially over the past ten years. He doubts that some who claim to have gold in their vaults actually do.

Some Favorite Ideas:

• Norseman Gold PLC (ASX:NGX)
• Corridor Resources (TSX:CDH)
• Sensio Technologies (TSX-V:SIO)

Jonathan Heller, CFA
No postions

Kian Ghazi is with Hawkshaw Capital Management. He starts up by discussing previous picks in Wesco and Learning Tree and how they have played out.

Hawkshaw is a long/short U.S. equity investment partnership. There is a heavy emphasis on research investigation.

How do we invest with conviction?

Value investors identifying high quality one of a kind franchises that are financially strong. Then they kick the tires and uncover the land minds. Ask what could send the stock down 30% or more that would cause us not to want to buy substantially more stock.

Financially strong companies have rock solid balance sheets, positive free cash flows, and monetizeable assets.

Universal Technical Institute (UTI) is a technical school that trains mechanics, primarily auto mechanics. It trades around $15 right now.

What hit this stock? A perfect storm. The company increased capacity by 35% from 2005 to year-end 2006. Company-wide students starts turned negative shortly therafter (2Q06). This pressured margins. The strong labor market and student loan problems this year has really impacted the company.

Ghazi argues enrollment growth is poised to re-accelerate meaningfully through increased demand and improved operations. Analysts are not appreciating this. There is over concern about student loan market. He thinks normalized earnings power is about $2, which is twice the consensus.

There are some good trends. About 50% of qualified mechanics will retire over the next 7-10 years. UTI is twice the size of its nearest competitors. The value proposition here is compelling for the $25,000 investment. Ghazi estimates the return on this educational investment is 25% and if levered it is more like 50%. There are many OEM partners that reduces the capital outlays necessary for operating and equippling UTI campuses. The OEMS include BMW, Harley-Davidson, and many other auto manufacturers.

There exposure to the subprime market is very small. From 2003 to 2005 the company was hitting on all cylinders. Then management failed to adjust to changing employment market. The affordability of the program declined and the educational funding gap increased over time from $7,000 to over $12,000. This resulted in leads dropping by double digit rate. Those that show up after a contract went way down. In 2007, the federal government reduced the subsidies to student loan providers. UTI began funding the gap of subprime loans to students and this caused concern to the market.

As unemployment rate rise, enrollment rises. In 2006 and 2007, high school students could go into construction and make $30 an hours, so they were not finding it attractive to pay to become mechanics.

They have changed the SVP of marketing in January 2007 and the SVP of campus sales in September 2007. They also improved the marketing from infomercials to 30/60 second ads. They improved the company website and spend more time with prospective students to encourage them to enroll and stay in the program. Leads are already starting to grow in the most recent quarter (3Q2008). There was a 41% increase in leads. Modest contracts growth can lead to a high shows growth.

Under the presented scenario there is a potential value of $30 per share.

What could drive this stock down 30%? It could happen if students can’t secure financing, but it appears students still have access to prime loans. Regulatory issues could arrise if default rate spirals out of control and result in the school being cut off from federal student loans.

What you need to believe?

Contract growth: 5%
Show rate improvement: 3.5%
Starts growth: 12% for 2 years
Capacity utilization: 80%
Drop out rate: 30%
Incremental margins: ~50%
EBIT margins: 15%

With more relaxed assumptions, he could envision the stock being worth $45 per shares.

I must admit that I’m interested. My only concern is the amount of mechanics being trained by the military is probably high given the protracted war effort. The withdrawal of troops from Iraq could result in a surge of trained mechanics hitting the market.

George
www.fatpitchfinancials.com

Boykin Curry, Eagle Capital

Curry led off day 2 at the Fourth Annual New York Value Investing Congress, with a presentation on “Time Arbitrage”. Curry believes that investors are still too focused on short-term company performance, which leaves plenty of opportunities on the table for those wiling to do their homework, and look past the next 8 quarters.

Curry sees this prevalent short-term focus as an arbitrage opportunity of sorts, one that unlike most arb scenarios is actually widening. He cited an unbelievable statistic, that being that 81% of questions asked during quarterly earnings calls are focused on the next 12 months, while just 19% are longer-term oriented.

Curry cited American Express as a great example of a company that is currently mispriced due to the shortsightedness of Wall Street and the investment community at large:

• Amex is not a credit card company-just 20% of revenues
• Amex is the world’s largest buying cooperative of affluent buyers
• Analyst haircuts to forward estimates don’t equate to the reduced market cap they place on the company
• Credit crisis/chare off concerns are overdone for Amex

Kian Ghazi, Hawkshaw Capital Management

Ghazi presented “ Investing With Conviction”. Hawkshaw’s Philosophy is centered on intensive, “deep dive” oriented research:

•  Concentrated long/short US equity portfolio
• Proprietary investigative research
• Value focused
• Identifies high quality, “one of a kind” franchises
• Ensures that they are financially strong (ample cash, FCF)
• Asks; “What could go wrong and send stock 30% lower, that would cause us to not want to but more?

Ghazi presented the case for Universal Technical Institute (UTI), which provides in-depth auto technician training.

• Stock has been beaten down in recent years due to excess capacity, falling enrollment, poor marketing strategies, and rising tuition
• Company turning things around: Congress Increased student loan limits
• Currently at $15, Ghazi believes company could earn $2.00 per share in 2009, could be worth at least $30

Jonathan Heller, CFA

Disclaimer: I have no positions in any of the companies mentioned