Value Investing Congress Blog

Whitney Tilson and Glenn Tongue move on from their presentation on the housing bubble and credit crisis to their current stock picks. They present on EchoStar (SATS), Fairfax Financial (FFH), and Berkshire Hathaway (BRKa).

EchoStar

EchoStar Corp. is a spinoff of EchoStar Communications (DISH). They make set-top boxes, but also includes Slingbox. Also has satelites/broadcast business.

Sum of the parts analysis

Cash: 1.1 billion
Satellites/Broadcast: 1.2
$2.3 billion

Set-top box: 1.6-2.4
Technology (slingbox) 0.4
Investments 0.3-0.5
Total $2.3-3.3 billion (25.60-36.60/share)

EchoStar not buying back stock because they are seeing better deals for their stock.

Fairfax Financial

T2 use to be short Fairfax Financial when they were so weak one hurricane could take them out. Now Tilson is long as the company has strengthened. Fairfax Financial CDS portfolio has paid off nicely.

Should trade 1.3 to 1.5 book. Right now trading at around 1.25 book, but they have added 574.5 in realized cash proceeds from selling CDS in the third quarter so adjusted P/B is more like 1.16.

You are getting a great CDS portfolio but there is a high short interest ratio. The company is buying back stock and their behavior does not indicate they are likely to be crooks.

Berkshire Hathaway

T2 estimate of Berkshire Hathaway’s intrinsic value is $157,000/share and forward value of $178,000/share. Berkshire Hathaway is apparently down 5% today.

Questions

Tilson doesn’t believe the Community Reinvestment Act and Fair Housing Act was a major contributor to this problem. Fannie Mae and Freddie Mac were some of the only lenders to maintain standers. Their problem was that they got sucked into increasing leverage too much.

What’s your outlook for consumer exposure? They regret being early. They were long retailers, but short real estate broad index and retail real estate REITs. Therefore, they are not down as bad. They want the best companies in the worse out of favor sectors. They are looking at buybacks being made by retailers. Sears is buying back lots of stock with their cash.

Tongue discusses Target (TGT) thinks they will be a relatively strong company as they survive this crisis. They will loose a year of cash flow but it won’t materially impact the DCF for Target.

Will there be a great bust in municipal bonds? A big question and Tilson doesn’t invest much in bonds. Tongue responses to the analogy of the Great Depression and doesn’t think with the appropriate action we will end up in that position. Will they need a bailout? They will likely get one if they need it. The example here is the California general revenue bond. Tilson expects default rate for municipalities will increase, but not be widespread like a Great Depression.

George
www.fatpitchfinancials.com

I’m at Value Investing Congress in New York City this morning. I’ve already caught up with Todd Sullivan of Value Plays and Vitaliy Katsenelson from Vitaliy’s Contrarian Edge.

Whitney Tilson and Glenn Tongue are giving the first presentations on the housing bubble and credit crisis. Tilson steps through the historical data on housing and borrowing. Some of the data was just updated late last night for this presentation.

Subprime mortgages were still a small part of the debt. Repackaging loans was one of the most profitable businesses at Wall Street, but volume of product was needed. Lenders became lax because they assumed the underlying assets would remain strong. Defaults in a strong real estate market were not really a concern.

Foreclosures are accelerating with no signs of a let up. New home sales are still strong but inventory has increased to 1 year. Home vacancies are at an all-time high. Quadrupling of the number of homes selling in foreclosure has occurred recently and regular existing home sales has declined. 42% of homes in August in California for sale has been in foreclosure.

You can still borrow 5 times your income, a 39% decline, but still much higher than the historical level.

Home prices down almost 20% based on Case-Shiller index. Home prices are about half way down the predicted decline according to Tilson. Home prices versus income ratio however might indicated that the housing market has finished declining. Good news is that mortgage rates have started declining as a result of Fannie and Freddie were nationalized. Nonconforming mortgages are disappearing. The rate of housing decline seems to have improved. However, April, May and June are seasonally strong house prices. Therefore, we might have another 12-18 months of home price declines. July housing price change has ticked back down in the latest month, July.

Glenn Tongue then continues the presentation. What does the future hold? It appears the subprime reset bubble is behind us, but the alt-ARM loans resets will surge in 2010-11. These could be a lot more painful to the borrower. There is close to $1 trillion in Alt-A loans.

What are Option ARM loans, also known as pick-a-pay loans? They are made to a prime borrower. They were low or no document loans (liar loans). Each month borrowers could pick one of three choices to pay: the fully amortizing interest and principal, the full interest, or an ultra-low teaser interest only rate (typically 2-3%). They looked really good on lenders books, but result in really “bad stuff.” People will typically default when they recast if the homes don’t appreciate.

There was not as much payment shock in subprime as base rates came down. However, the negative amortization of Option ARMs still causes a great payment shock when they recast.

HELOCs and closed-end second mortgages and the next thing to be discussed. They are effectively mortgage insurance. They are second to everything and there is no asset to lock onto during a default. MBIA agrees that defaults will cause 100% severity in HELOCs and closed-end mortgages. Many banks have large exposures to these.

The timing indicates that we are still in the early stages of the bursting of the great mortgage bubble. The scary scenario being presented is that we are only at the tip of the iceberg of an enormous wave of defaults, foreclosures and auctions in the U.S. housing market. This presentation paints a much scarier scenario than I’ve been contemplating. It is overwhelming and depressing.

Tilson comes back with some dramatic maps of the various loan levels since 2004. You can really see the reduction in lending standards in 2006. The default rates historically have been around 1% and are now shooting up to the high single digits, some even degrading before they reset.

Banks and brokerages have taken approximately $500 billion in writedowns and raised $353 billion. Tilson closes out the discussion by going over CDOs and other mortgage backed securities.

This presentation is available for download at this Value Investing Congress link.

George
www.fatpitchfinancials.com

Noven Pharmaceuticals (Nasdaq: NOVN) recently made significant changes to its board of directors and senior management. The company hired a new CFO, accepted the resignation of its long time Chairman and CEO Robert C. Strauss, and appointed Wayne P. Yetter as its new Chairman. We applaud these actions and believe a tremendous amount of value will come from the changes.

The Chairman and CEO roles are now separated, and Mr. Yetter has an outstanding reputation and track record. He is the former CEO of Novartis Pharmaceuticals and Astra Merck, and also served as the COO of IMS Health, all large and successful companies. Interestingly, Mr. Yetter was the CEO of Novartis at the time it established the Novogyne joint venture with Noven. For a company with an enterprise value of only $250 million, Noven has an impressive leader at the helm.

Noven has appointed Jeffrey F. Eisenberg, Senior VP of Strategic Alliances, as Interim CEO and expects to announce a new CEO shortly. We believe that a well recognized industry leader with a proven track record will be appointed. Noven presents an outstanding opportunity for a top notch executive to take charge of a profitable company with a very flexible balance sheet, at a time when its stock is extremely depressed and its opportunities are abundant. In our opinion, prior management did not aggressively exploit Noven’s drug delivery platform or utilize its overcapitalized balance sheet.

The company has best-in-class drug delivery technology and a deep pipeline of products – both proprietary and with market leading partners – in various stages of development. In addition, Noven’s strengths play into the key challenges faced by Big Pharma today. Its patented Dot-Matrix technology differentiates products and extends patent life, while requiring a short timeframe for regulatory approval and a relatively small amount of development capital. In addition, Noven has outstanding proof of concept via its Vivelle-Dot patch for Estrogen Therapy and its Daytrana patch for ADHD. Both are market leading products with no close competitors.

We see tremendous value in Noven, which should become apparent to the market as new products are approved and a new management direction takes hold. We believe Noven’s 49% ownership of its Novogyne joint venture alone is worth 40% more than its current enterprise value, and that does not attribute any value to its four additional approved products or its robust product development pipeline. At present, we believe Noven’s stock is selling for $0.38 on the dollar. A significant share repurchase would be extremely accretive, and the pursuit of strategic alternatives would likely catapult the stock. Regardless of the means, we are confident that the gap between Noven’s share price and its intrinsic value will be closed over the long term.

At the 3rd Annual New York Value Investing Congress on Wednesday, Bill Ackman announced that he expects the holding companies of MBIA and Ambac Financial to fail as soon as next year. Further more, he stated that he will donate the hundreds of millions which he expects to earn from those short positions to charity.  You can view Bill Ackman’s presentation at pershingsquare.valueinvestingcongress.com .

The Value Investing Congress was a huge success. Many of you have told us that it was our best Congress yet. We would like to thank all of you who attended the Congress and invite you to share your thoughts with us by posting your comments to this blog entry.