Value Investing Congress Blog

The Mortgage Crisis
Whitney Tilson and Glenn Tongue of T2 Partners kicked off day 2 with a sobering look at the mortgage crisis. For his part, Tilson believes that we have not yet seen the worst. His extremely detailed presentation (“The Latest on the Mortgage Crisis and Implications for Certain Financial Stocks”) 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, Washington Mutual, 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).

Glenn Tongue gave an excellent overview on Berkshire Hathaway, making the bullish case based on:
• Over –capitalization
• In a great position to take advantage of opportunities this market presents
• Remains the premier capital allocator
Tongue Valued Berkshire on:
• Investments/share ($90,342)
• Plus PV of future pre-tax eps (excluding investments)
• Intrinsic Value of $156,000- $159,000, a 20% premium to current price
We can only hope that Whitney and Glenn are wrong on the depth of the mortgage crisis (wishful thinking) and right on Berkshire’s valuation.

Aaron Edelheit- Sabre Value Management
One of the very pleasant surprises this year was newcomer Aaron Edelheit, whose passion for value investing was very apparent in his presentation. Edelheit pointed out the outstanding returns from the small cap value area of the market since 1970 (16.2% annualized), but noted the disinterest here from many investors. He cited the following reasons for this situation:
• Small Cap Value can be very boring to investors
• There may be long periods with no news
• Illiquidity associated with SCV companies scares investors
• Too much volatility
• Little or no analyst coverage
One of Edelheit’s favorite ideas is Hemisphere GPS (HEM CN), formerly CSI Wireless. This misunderstood company is his largest holding.
• Hemisphere operates in the agricultural GPS arena, offering “auto steering” technology to farmers, which allows for more efficient use of tractors and thus their acreage, seed and fertilizer
• Pricing of HEM’s products are very favorable
• He forecasts rapid sales and earnings growth on the horizon

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

The afternoon session was chock full of practical value investment techniques, applicable to real situations. Here are just a few of the highlights:

Washington Mutual
Having already stated their belief that the mortgage crisis is not over yet, Whitney Tilson and Glenn Tongue presented a negative view of WAMU (they have a short position):
• The concern centered on HELOC exposure (home equity lines of credit), junior liens, and option Arms. In the case of option ARMs, 62% of exposure came from two of the most challenged markets: California (49%) and Florida (13%).
• Tongue expected the company to lose $5 per share this year
• Significant shareholder dilution occurred when the company issued $7 billion in stock in April
• Tongue stressed the importance of doing your homework -and having a working model to assess true exposures -when taking a position (either long or short) in a company such as WAMU.

Retailers:
Tilson suggested that although now is not the appropriate time to be long a basket of retailers given the current economic situation, there are some bargains out there. He presented a bullish (and compelling) case for Target (TGT):
• buying back stock ($10 billion buyback program)
• selling credit card ops—(interestingly enough, the news of the sale of 47% of this business to JP Morgan for $3.6 billion broke during the conference)
• Owns a large percentage of its land and buildings—real estate alone may be worth 70-80% of current market cap
• Potential $5.00/share eps 3 years out (stock currently $53)

Tongue presented the bullish case for Sears Holdings (SHLD):
• Repurchased 33 million shares the past 3 years
• Sum of the parts potentially worth a great deal more than current market cap ($13 billion)
• Real estate alone- 250 million square feet- currently being valued at less than $10/sq ft assuming conservative $11 billion valuation of business units
• Trading at significant discount to current $100 price

Other Highlights:
• Bearish on Allied Capital (ALD -short position)—company surrounded by controversy, and may be a house of cards ready to fall.
• Bearish on Crocs (CROX- short position)—which may be a textbook version of a fad stock—explosive growth, unsustainable margins, and no competitive advantage, all of which is a road to nowhere.

Tilson and Tongue put on a great seminar—well worth the price of admission, and highly recommended to anyone who wants to learn practical applications of value investing taught by successful professionals who practice the art each and every day.

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

Whitney Tilson and Glenn Tongue, co-portfolio managers of T2 Partners, presented on November 29, 2007 at the 3rd Annual New York Value Investing Congress to a standing- room-only crowd at Rose Hall in the Time Warner Center. This link will take you to their presentation, which also argues that Berkshire Hathaway is somewhat undervalued but offers an immense margin of safety. To learn more, click on http://www.valueinvestingcongress.com/download/T2_VIC07.pdf.

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.