Value Investor Insight Issue 336

ValueInvestor
March 30, 2012
The Leading Authority on Value Investing
INSIGHT
F E AT U R E S
Capital Appreciation
Owning companies that are unlikely to generate headlines or set pulses racing has paid off more than handsomely for Fiduciary Managements Pat English.
Inside this Issue

Investor Insight: Pat English Casting a wide net for high quality at low prices and finding it today in Henkel, Sysco, Arrow Electronics and Compass Group. PAGE 1 Investor Insight: Shawn Kravetz Sticking to his knitting to identify mispriced securities such as Skechers, MEMC Electronic, Wacker, Ministop and Lakes Entertainment. PAGE 1 Uncovering Value: Poseidon A low-profile player with a disruptive solution in a high-profile corner of todays energy market. PAGE 18
at English wasn't planning to be in it for the long haul when he joined Milwaukee's Fiduciary Management, Inc. as an analyst in 1986. He'd moved to follow his wife as she pursued a medical degree I wasn't expecting to make a long-term investment, he says. Fiduciary investors can be glad he did. English, now CEO of the $12.5 billion (assets) firm, has been a driving force behind its flagship small-cap strategy earning a net annualized 14.8% since 1980, vs. 10.6% for the Russell 2000. Focused on companies obsessed with their own returns on investment, English is finding opportunity today in such varied areas as adhesives, consumer products, pharmaceuticals, technology distribution See page 2 and food services.
INVESTOR INSIGHT
Pat English Fiduciary Management, Inc. Investment Focus: Seeks companies whose under-pressure stock prices most misrepresent the underlying return-oncapital dynamics of their businesses.
Uncovering Risk: Diamond Foods Is this beleaguered food company a compelling contrarian bet ... or an ongoing train wreck? PAGE 20 Strategy: Zeke Ashton Centaur Capitals founder outlines the essential elements of a built-tolast investment strategy. PAGE 21
INVESTMENT HIGHLIGHTS INVESTMENT SNAPSHOTS
Arrow Electronics Compass Group
Ins and Outs

While his industry focus might be considered relatively limited, Shawn Kravetz's ability to recognize mispriced stocks has proven to be far more expansive.
INVESTOR INSIGHT
PAGE 5 8 20 7 16 12 15 18 14 6 13
Shawn Kravetz Esplanade Capital Investment Focus: Seeks growth companies at value prices, for which he's early in recognizing potential and believes marginal economics will surprise on the upside.
ne theoretical knock on investors who specialize by industry is that advocacy can eventually taint their objectivity. To Shawn Kravetz, however, that's much less of a problem for managers as willing to go short as long. Focusing on a sector does not mean we're long in it, or even that we're invested in it at any given time, he says. Kravetz's discerning taste has served his investors quite well since he founded Esplanade Capital in 2000. His flagship fund has earned a net annualized 8.1% since inception, vs. 1.3% for the S&P 500. Gravitating often to turnarounds and off-the-beaten-path small caps, he sees mispricing today in such areas such as solar energy, footwear, casino gaming and See page 10 Japanese convenience stores.
www.valueinvestorinsight.com
Diamond Foods Henkel Lakes Entertainment MEMC Electronic Materials Ministop Poseidon Concepts Skechers Sysco Wacker Chemie
Other companies in this issue:

Alliant Techsystems, Archon, Comerica, Dentsply, Devon Energy, FamilyMart, First Republic Bank, GlaxoSmithKline, Las Vegas Sands, McGraw-Hill, Patterson Companies, Sanderson Farms, Staples, Tokuyama
I N V E S T O R I N S I G H T : Pat English
Investor Insight: Pat English

Pat English and Andy Ramer of Milwaukees Fiduciary Management, Inc. describe what quality means to them in assessing a business, why they'll make exceptions to buy in industries they usually avoid, what golf lessons translate to investing, and what they think the market is missing in Henkel, Arrow Electronics, Sysco and Compass Group.
Your strategy focuses on assessing a companys business before its stock. Describe the primary elements of that. Pat English: Our fundamental belief is that top management and Wall Street are overly optimistic, which leads to inefficiency in how stocks get priced. For a time that may be to the upside, but it works on the downside as well when theres the inevitable disappointment. Our goal is to have identified a full bullpen of companies that we believe have good businesses, so that were prepared to take advantage when disappointment hits and their shares become attractive. These bullpen companies have certain typical characteristics. They have high levels of recurring revenue. They have minimal financial risk little to no net debt for smaller-caps, and no more than 30-40% debt to total capital for large caps. Their businesses arent complicated, nor are the investment theses. We pay careful attention to our return on time, so were not interested in tackling highly complex, time-consuming ideas. Our most important focus is on understanding a business' return on invested capital and, perhaps more importantly, its return on incremental invested capital, which I've learned to appreciate more and more over the past 25 years. We scrub the financials to get a reliable picture of the companys historical full-cycle ROIC and want to see it significantly ahead of its weighted average cost of capital, which means the company is creating shareholder value. If a bad acquisition has been written off, for example, well evaluate whether some or all of that writeoff should be added back to the capital base in assessing the return on capital. Were not just looking backwards, but also want to see that prospective returns based on our estimates of
March 30, 2012
earnings and the investments necessary to generate those earnings are going to be attractive. Related to this emphasis on ROIC, were looking for management with a clear shareholder focus. What you have too often is a mentality that bigger is always better: If an acquisition offers a 5% ROI and cash is only earning 2%, do it. This doesnt make sense it adds risk and likely doesnt cover the true cost of capital. If thats all they can do with the money, wed rather they return it to us and well reinvest it somewhere else. To foster our way of thinking, we want top management paid on returns, not growth, and for them to own stock outright rather than through options. The only way to think like an owner is to actually be one. What puts pressure on share prices of companies you admire? PE: Its often normal cyclical or companyspecific pressure that Wall Street has no patience to see through. We like it when Street research talks about waiting for industry fundamentals to improve or for evidence that a turnaround is taking hold. Once those things happen the stock may have already moved 25% or more. If we believe the pressure is temporary and the valuation is compelling, well take that time risk. Andy Ramer: To give an example, we bought Sanderson Farms [SAFM], the fourth-largest producer of chickens in the U.S., in January 2011 when the stock fell into the $30s because the industry was losing money due to rising supply, falling demand and higher commodity feed costs. Wed seen this before and were comfortable that the industry and company were responding and that the imbalances would work out over 12 to 18 months. We were surprised how quickly
Pat English
Of Course
By the end of his freshman year at Stanford, Pat English started to reconsider his dream of being a professional golfer. I was fifth on my college team. Given the number of division-one programs and how many players made it on tour, I didn't need to be a genius to figure out that wasn't going to happen, he says. His backup plan has proven to be a holein-one. After graduation, English spent two years as an analyst at Dodge & Cox and in 1986 joined Milwaukee's Fiduciary Management, where by 1989 he was Research Director and where he is now CEO and Chief Investment Officer, overseeing $12.5 billion. With a son starting out in the business, English draws on his own time as a golfer for lessons to impart. I tell my son often about this guy on our Stanford team we called Moon Man, who seemed to be operating in this lunar zone of some sort. His swing wasn't great and he didn't strike the ball that cleanly, but he always scored well because he never blew himself up. Investors forget that lesson all the time and over-reach, over-concentrate and take on too much risk none of which is necessary to score well.
Value Investor Insight 2
the market starting pricing in the recovery, so sold our stake at the end of last year when the stock was in the low $50s. PE: Its not always a cyclical issue. One good example that goes back to late 2008 is McGraw-Hill [MHP], which we bought when the stock traded down toward $20 as the market feared that the Standard & Poors ratings business was doomed and that the educational business faced potential spending cutbacks and vulnerability to the digital distribution of books. Our basic view was that these issues were manageable and that both franchises were sounder than the market believed. On a sum-of-the-parts basis we thought the stock was worth $45-50, which is close to where we sold it in the fourth quarter of last year. There is likely more value there, but we were disappointed that despite the heavy pressure activist investor JANA Partners put on the company, the best it could do was a spinoff of its education business. At the then-current price, we werent willing to accept the regulatory and litigation risk that remained for the ratings business. Youve written about getting interested again in pharmaceutical stocks. Whats behind that? PE: It was our contention for some time that the research efforts of the large pharmaceutical firms were not generating positive economic value. The cost of newdrug development and the length and uncertainly of the regulatory approval process had changed so significantly that the expected net present values of drug pipelines had in many cases turned negative. Stocks that looked cheap really werent if you valued the drug pipelines correctly. It has taken years, but this dynamic has been changing. Industry management is taking a much more thoughtful approach toward how theyre spending R&D money and we believe the net present value of drug pipelines is again turning positive. The companies have also begun to trim bloated overhead strucMarch 30, 2012
tures. To the extent the market is slow to recognize this, there can be opportunity in select cases. Whats a representative current example? PE: GlaxoSmithKline [GSK] is one we believe is well positioned because of its less onerous patent-expiration issues, its diversified product mix across therapeutic classes, geography and molecular for-
ON NATURAL GAS: The time to buy is when supply is full and pricing is depressed certainly the case with natural gas today.
sheet, and its return on invested capital over a cycle is in the top three in the industry. The stock [at a recent $70.60] is under pressure because of the severe downdraft in natural gas prices, but we think the market is missing the deep portfolio of liquids-rich areas Devon can target for development over 90% of its current capex is going into crude oil or wet gas and on which it can earn very nice returns. The time to buy commodityrelated businesses is when supply is full and pricing is depressed, which is certainly the case with natural gas today. In this managements hands, were more than willing to ride out the cycle. PE: The issue with banks is primarily that its too difficult to see the assets and do our own underwriting of the loans and investments they make. They get their ROE from high leverage and low margins, which is a risky premise from the get-go, and they go through loan booms and busts that make returns over time not very good. Wed much rather own a money manager, say, which has high margins and low leverage and has nice returns through a cycle. Comerica [CMA] looks like a Devon-like exception in your portfolio. Why is it a bank youre willing to own? PE: Comerica has an excellent long-term credit track record, which makes us less concerned about the black-box nature of the business. Were comfortable we understand what it does, which is basically plain-vanilla lending with nothing exotic elsewhere on the balance sheet. The stock [now trading at $32.30] has been under a cloud because the economy has been weak and the interest-rate environment has been poor. We basically view this as an excellent call option on both of those trends eventually returning to the mean. On what do you primarily focus in your research? PE: Weve developed over 25 years a comprehensive research format we go
mulations, and its new-product pipeline that is showing improved productivity and has a number of meaningful, novel drugs in phase-III development. When we bought this in the third quarter of last year, the valuation to us implied that the market viewed the existing drug franchises as almost a runoff-asset situation and placed little to no value on the pipeline. On a sum-of-the-parts basis, we still believe the stocks fair value is 6075% higher than the current share price [of $45], while in the meantime were earning a better than 5% dividend yield. You largely avoid both energy producers and banks. Why? AR: In energy exploration and production, the commodity nature of the business makes companies struggle to earn their cost of capital over time, but what concerns us as much is that management teams too often dont even focus on ROI and just want to grow. When we find exceptions to that, we will invest. We own Devon Energy [DVN], for example, which has a production mix that is about two-thirds natural gas and one-third oil and natural gas liquids. It has superior acreage positions with low entry costs and royalty burdens, a great balance
through in vetting ideas, with a detailed list of questions to answer about every prospective investment. A big part of that goes toward understanding industry dynamics and trends, the competitive environment, and how the company stands apart in any number of areas its products, distribution, cost structure, selling effort, etc. Also key is understanding how management makes capital-allocation decisions not surprisingly focused on the emphasis on return on capital how they measure it and how theyre compensated on it. This is often where well hit roadblocks. For instance, Dentsply [XRAY] is in a business we love, an oligopoly providing dental supplies that mostly arent subject to reimbursement and that produce stable, recurring revenues. Wed like to own it, but management seems to have decided the best path is to do acquisitions we believe are value-destructive. Well keep it in our bullpen until that changes. Our financial analysis centers on assessing margins, earnings power and returns on capital over time. We set target prices based on the valuation levels at which we believe companies with certain margin structures and return profiles should trade. If its a 10% EBIT-margin business through a cycle, say, well be interested if it trades at less than 1x revenues on an enterprise-value basis. Were often counting on the business improving from some level of under-earning today, which will also result in a revaluation say from 0.7x EV/Revenues to 1.2x as that happens over the ensuing few years. We always ask before buying whether wed be comfortable putting the stock in a lockbox for five years and not touching it. If were not, we shouldnt buy it. Thats not an argument for putting your head in the sand, but we think you need that level of confidence in the business to think most clearly when things go temporarily awry and clients are questioning you. You run very concentrated portfolios given your level of assets. Why? PE: In small cap which for our purposes is anything under about $4 billion in
March 30, 2012
market cap we typically have about 45 stocks. Our large-cap and international funds each have about 25 positions. Given some overlap in large cap and international, that means we own roughly 85 unique names at a time. Our basic goal is to hold enough stocks to be well diversified across industry sectors, while not holding so many that our investment team becomes difficult to manage. We dont mimic our benchmarks, but we do believe its prudent to have exposure to most major economic sectors. In our large-cap portfolio, for instance, our 25 stocks are probably going to represent 60 different
described earlier in speaking about Dentsply. Patterson is a high-ROI business, with lots of recurring revenue, secular industry tailwinds, a great balance sheet and plenty of liquidity in the market. The negative investment issues are primarily related to the stagnant economy. Given our conviction in the business long term, were happy to make it a larger position. Describe why Arrow Electronics [ARW] is high on your conviction list today? PE: Were typically not attracted to most technology businesses because of cutthroat competition, potential technology obsolescence, short product cycles, and the excessive use of stock options. The return on time is also a problem you spend so many hours analyzing new products and technology trends that 50% of your time gets spent on 5-10% of your portfolio. At the same time, technology is an important driver of economic growth and grows at above-GDP rates, so we want to have exposure to it. We like to attack difficult industries through the side door, so to speak. In Arrow, we have a leading distributor of technology products including semiconductors, software and electronic components that supplies mostly small and medium-sized companies. That allows it to benefit from the growth in high tech without the typical risks associated with tech stocks. How high-quality do you consider this business? PE: Its gotten much better in recent years. Its more geographically diverse, with 50% of Arrows revenues coming from the Americas, 30% from Europe and the rest from Asia. The company has 1,200 suppliers and more than 125,000 customers, so theres no over-dependence on certain products or vertical markets. Management recognized a number of years ago that growth for growths sake was not conducive to shareholder value, so they re-focused on turning assets more rapidly and pursuing a better mix of busiValue Investor Insight 4
ON TECHNOLOGY: We like to attack difficult industries that are important drivers of growth through the side door, so to speak.
industries. We have an unwritten rule that each of our investment professionals essentially puts their entire net worth only in our stocks. This focuses everyone on what is best for clients and is also a good risk mitigator in that with your net worth on the line, you will be sensitive to diversification and prudence in all that you do. We have a total of seven analysts, including myself, and we believe when investment teams have more than 10 people they start to break down. Egos get in the way, people start to specialize and you just cant have the quality of collective discussion we think is necessary. Do you follow any particular rules on position sizes? PE: Its fairly rare for a position in any of our portfolios to get higher than 5-6% of the portfolio, but we do make distinctions based on our level of conviction. One of our biggest small-cap holdings, for example, is Patterson Companies [PDCO], which is in the dental-supply market I
nesses. Over a full cycle, we see this as a 12-13% ROI business. Isnt there plenty of cutthroat competition in this market? PE: Avnet [AVT] is the primary competitor and has done battle with Arrow for decades. But this is still a big and growing industry, with over half of the market made up of smaller players that dont have the economies of scale and supplier relationships that Arrow and Avnet do. That leaves plenty of opportunity for both of the leaders to take additional share. There are also ample growth
INVESTMENT SNAPSHOT
opportunities in new product categories and overseas. How inexpensive do you consider Arrows shares at a recent $42? PE: We think theres a real disconnect between the current valuation and the improved quality of the business. It used to be that when Arrow went through a down cycle it would be lucky to make money, but indicative of how the structure of the business has changed, it made good money through the last cycle and was still earning its cost of capital even at the cycle bottom.
Given its long-term return on equity profile and assuming a normalized EBIT margin level of roughly 5% its 4.5% today we believe Arrows stock should trade at 50-60% of revenues on an enterprise-value basis. Its traded in that range many times in the past when it was arguably a much inferior business but today the stock trades at only 28% of revenues. At 55% of $22 billion in revenues, the enterprise value today would be around $12.1 billion. Less $1.5 billion in net debt would leave a market cap of $10.6 billion, which on 112 million shares outstanding would translate into a share price of $95. Once the market stops treating Arrow as some sort of pariah, theres just enormous upside in the stock. Sticking with the side-door theme, describe your interest in Sysco [SYY]. PE: Sysco is the largest food distributor in North America, distributing 300,000 products to roughly 400,000 restaurants, schools, hotels, nursing homes and other food-service providers. Restaurants account for about twothirds of the business. Restaurants are by and large not very good businesses highly competitive, tough to manage and not particularly profitable over time. Youll have the rare breakout growth story like Chipotle, a stalwart to invest in like McDonalds and maybe an occasional turnaround, but its a tough area for value investors. That said, due to demographics and changes in lifestyles, the restaurant business overall is secularly growing. Just as we want to get at technology growth through Arrow, we believe Sysco provides similar access to restaurants. And Sysco is an even better business. Its the industry leader with 18% of the U.S. market, twice the size of the next biggest player, US Foods, and is much more profitable. It has very high recurring revenue and a route-based model in which the incremental customer is extremely profitable. Even in a shaky economic climate and with some self-inflicted wounds, its earning almost 20%
Arrow Electronics
(NYSE: ARW)
Valuation Metrics
(@3/29/12):
Business: Global distributor to OEMs and commercial users of technology products, including semiconductors, storage devices, software and electrical components. Share Information
(@3/29/12):
Trailing P/E Forward P/E Est.
ARW 8.1 8.4
S&P 500 16.2 13.6
Largest Institutional Owners

(@12/31/11):
Price
52-Week Range Dividend Yield Market Cap
Financials (TTM):
42.07
25.71 47.50 0.0% $4.71 billion $21.39 billion 4.4% 2.8%
Company Fidelity Mgmt & Research Wellington Mgmt Artisan Partners First Pacific Advisors Vanguard Group
Short Interest (as of 3/15/12):
% Owned 9.8% 9.7% 8.1% 4.3% 4.1% 1.0%

50
Revenue Operating Profit Margin Net Profit Margin

ARW PRICE HISTORY 50
Shares Short/Float
40
40
30
30
20
20
10
2010
2011
2012
10
THE BOTTOM LINE
Even though it has significantly improved the quality of its business and offers a sidedoor way to play technology growth, the market treats the company as some sort of pariah, says Pat English. At the EV/Revenues ratio at which he believes the shares should trade and at which theyve traded in the past the stock would be $95.
Sources: Company reports, other publicly available information
March 30, 2012
returns on invested capital. This is one where if you think in terms of the lockbox analogy, you could put this away for five years and be pretty confident upon opening the box that the challenges have ameliorated and that the core business was fundamentally sound. What are the challenges youre expecting to get better? PE: One is high unemployment, which translates into fewer out-of-home meals and a shift in spending from the casualdining outlets Sysco mostly serves toward quick-service restaurants like McDonalds
INVESTMENT SNAPSHOT
and Chipotle. Some people think casual dining is now in secular decline, but we dont believe that. The changes in lifestyles and consumer habits that fueled the casual-dining boom are unlikely to have permanently disappeared. Another big issue for the company has been its giant enterprise resource planning [ERP] software implementation, which has been a beast. This year and next are the maximum spending years, and the entire system will cost them over $1 billion before its fully operational. The goal is to dramatically improve supply-chain efficiency and productivity, improving customer service while driving
down costs. Its very difficult to say how Syscos efforts will ultimately pay off, but we have no reason to believe they wont, and weve seen similar companies like W.W. Grainger leverage their new ERP systems to achieve significant margin improvement. At the moment, the effort is costing them approximately 35 cents per share in earnings on top of the capitalized costs and management distraction. That dynamic will obviously change as the project winds down. What upside do you see in the shares, now at $29.80? PE: Without the ERP-system spending and assuming modest improvement in the economy, we believe Syscos earnings could be pushing $3 per share within the next two years, up from a run rate of around $2 per share today. As earnings recover, wed also expect some multiple expansion. The companys average P/E multiple over the past ten years has been 19x, but even at 16-17x our estimate of normalized earnings, wed have a $50 stock. On top of that were getting a 3.6% dividend yield. Does acquisition-related growth concern you here? PE: We do normally look askance at growth by acquisition, but in this case it can make sense to do bolt-on acquisitions that can be integrated fairly quickly into the existing distribution system. More concerning today are the impact of higher gasoline prices on delivery costs and the potential for accelerating food inflation hitting both end-user restaurant demand and Syscos ability to pass on cost increases. Our assumption is that neither issue becomes too acute, but they are things to monitor. Turning to a non-U.S. idea, what attracts you to Germanys Henkel [HEN:GR]? AR: The company is interesting in that it has a strong position in both industrial and consumer end markets. Roughly half of the business is in adhesives, where
Sysco
(NYSE: SYY)
Valuation Metrics
(@3/29/12):
Business: Food and related-product distribution to restaurants, hospitals, nursing homes, schools and other entities serving out-of-home meals in North America. Share Information
(@3/29/12):
SYY 15.3 15.4
S&P 500 16.2 13.6

(@12/31/11):
Price
Financials (TTM):
29.78
25.09 32.76 3.6% $17.41 billion $41.02 billion 4.7% 2.8%
Company State Street Vanguard Group First Eagle Inv Mgmt Wellington Mgmt Invesco
% Owned 4.9% 3.9% 3.6% 3.4% 3.2% 3.5%

35 30 25 20 15

SYY PRICE HISTORY 35 30 25 20 15 2010
Shares Short/Float
2011
2012
THE BOTTOM LINE
The sluggish economy and a massive software implementation project that is currently all costs and no benefits is obscuring the enduring quality of the companys business, says Pat English. As those two challenges ameliorate, he believes the company can earn $3 per share within two years, justifying a share price of closer to $50.
March 30, 2012
Henkel is the global market leader supplying manufacturers in a broad range of industries, including mobile phones, cars, shoes, furniture and solar panels. Adhesives overall are taking global market share from fasteners, and Henkel benefits in the business from economies of scale and fairly high switching costs. We also like that while adhesives represent a minimal share of the cost of a given product, their contribution to its efficacy is substantial. There are a few cents' worth of adhesives in an Apple iPhone, for example, but the cost of failure is very high. On the consumer side, the company is a big player in laundry and personal care. Its better known brands include Dial soap, Purex and Persil laundry detergents and Schwarzkopf hair-care products. While not every part of this portfolio is firing on all cylinders, we like that these consumer brands generally benefit from good brand loyalty and ongoing repeat consumption. The company has been through a fairly significant operational overhaul. Is that process ongoing? AR: Most of the heavy lifting has been done since Kasper Rorsted took over as CEO in April 2008. He has discontinued or sold some weaker brands, rationalized the manufacturing footprint and significantly reduced headcount, resulting in operating margins increasing from 10% in 2007 to 13% last year. The target for 2012 is 14%, and we see no reason the business cant earn 15-16% margins on a normal basis. That would still fall short of what companies like 3M earn in adhesives or Procter & Gamble and Unilever earn in consumer products. Is this a growth story? AR: This is a typical name for us in that youre not going to see off-the-charts growth. The main drivers are the use of adhesives in new applications and strong emerging-markets growth across product lines. Just over 40% of total revenues today come from emerging markets, and
March 30, 2012
the company expects that will be 45-50% relatively soon. Over a cycle we expect the overall company to grow at a mid-single-digit annual rate, which it can leverage into low-double-digit EPS growth as margins expand. The companys consumer-products business in North America has been struggling. Is that fixable? PE: That is the part of the business that Wall Street is hung up on and it hasnt done well. They installed new management just over a year ago, which is focused on improving the companys product development and innovation, which has lagged. Were watching it closely and certainly dont want it to
INVESTMENT SNAPSHOT
break down further, but in the end this business accounts for less than 10% of total revenues and our view is that they will either turn it around or get rid of it, either of which would benefit overall margins. At a recent 46.20, how cheap are the shares? AR: The stock trades for 12.5x our 2012 EPS estimate of 3.70, while the European peer group trades at 18-20x. Given our view that this is an above-average company, we dont believe such a discount is warranted. Looking at enterprise value to revenues, the current multiple is around 1.4x, against the 1.8-2.0x at which we believe a company with this margin struc-
Henkel
(Xetra: HEN:GR)
Business: Producer of branded chemicalbased products focused on three primary business lines: Adhesives, Laundry & Home Care, and Cosmetics & Toiletries. Share Information
(@3/29/12, Exchange Rate: $1 = 0.752):
Financials (TTM):
Revenue Operating Margin Net Profit Margin

Valuation Metrics
(Current Price vs. TTM):
15.60 billion 13.0% 8.0%
Price
HEN PRICE HISTORY 50 40 30 20 10
46.17 30.22 47.32 1.5% 21.61 billion
P/E
HEN 16.0
S&P 500 16.2
50 40 30 20 10
2010
2011
2012
THE BOTTOM LINE
The market overemphasizes the companys lagging North American consumer-products business and underemphasizes its strong potential in adhesives and in emerging markets, says Andy Ramer. Based on peer comparisons and on where a company with its margin structure should trade, he sees 40-50% upside from todays share price.
ture and return profile should trade. However we come at it, we believe theres 40-50% upside in the share price from todays level. You own the ordinary rather than preferred shares. Whats the difference? AR: The preferred shares are more liquid and there is a minor difference in the dividend. The ordinary shares trade at a 15% discount, which we dont think is economically justified. Describe the case for global food-services company Compass Group [CPG:LN]. AR: Compass operates and staffs cafeterias, restaurants and coffee shops on an outsourced basis at corporate locations,
INVESTMENT SNAPSHOT
sports venues, universities and hospitals worldwide. That accounts for around 80% of revenues, with the rest coming from additional support services for things like cleaning, landscaping and security. Along with competitors Sodexo [SW] and Aramark, it is one of the few firms that can meet the needs of larger clients in multiple geographies and that can use its size for purchasing leverage with suppliers. This is a high-recurring-revenue business, with customer retention rates well above 90%. In addition, the outsourcing of food services is a global trend that still has plenty of room to run. Only 45% of the overall target market currently outsources its food services, and in certain sectors like education and healthcare that number is only 25-30%.
How does Compass distinguish itself against Sodexo and Aramark? AR: The breadth and quality of services are comparable, but what distinguishes Compass for us is the type of projects they bid on. It stays away from the highprofile project that might be very visible but doesnt generate much profit. They try to avoid competing with the other big players for deals, and are looking for projects where the quality and value of the service can trump just a low price. This approach trades off some growth for margin, which is perfectly fine with us. To give some historical perspective, Compass was an industry laggard for the first half of the 2000s, until Richard Cousins took over as CEO in 2006 and in a disciplined way got out of over 40 countries with sub-par profits, emphasized organic growth over acquisition, and instilled a clear focus on ROI. Operating margins went from 4.4% to nearly 7% from 2006 to 2011 and now lead the competition. The target today is 8.5%. The stock has done quite well over the past few years. What is the market missing with the share price at around 6.50? AR: The P/E on next years earnings estimate of 47 pence per share is around 14x, which we dont think adequately recognizes the quality of the business. We believe they can lever a top line growing at a mid-single-digit rate into high-singledigit EPS growth. With a better than 3% dividend yield, that would produce a 1213% annual total return on the stock. If the multiple expands to the 17x or so we consider reasonable for an above-average business like this, our annual return would be in the mid-teens. Speaking generally again, how well do you recognize mistakes and move on? PE: Any value investor needs to be highly sensitive to being on the wrong side of a secular issue. Its one thing to be contrarian and another to be foolish. A few years ago we owned Best Buy [BBY], which had a terrific track record
Compass Group
(London: CPG:LN)
Business: Provider of food-related services for clients such as factories, hospitals, schools and universities, sports venues, offshore oil platforms and military facilities. Share Information
(@3/29/12, Exchange Rate: $1 = 0.627):
Financials (FY ending 9/30/11):

Valuation Metrics
15.83 billion 6.4% 4.6%
Price
CPG PRICE HISTORY 8 7 6 5 4 3 2 2010
6.53 4.98 6.72 3.3% 12.34 billion
P/E
CPG 18.0
S&P 500 16.2
8 7 6 5 4 3 2011 2012 2
THE BOTTOM LINE
Having significantly revamped its operations and refocused on returns on investment, the company is poised to capitalize on global secular growth in the outsourcing of enterprise food services, says Andy Ramer. He expects EPS growth, dividends and some multiple expansion to translate into an annual mid-teens return on the stock.
March 30, 2012
but whose stock was under pressure from the poor economy and concerns over heightened competition from Internet sellers like Amazon. At the time we basically thought there was enough complexity around buying consumer electronics that Best Buy would hold its own against Amazon, but in watching Amazons electronic-product sales each quarter it become apparent that that basic premise was flawed. Best Buy wasnt doing terribly, but we almost couldnt believe how fast Amazon was growing. We sold the stock in 2009 in the low $40s, so while our original thesis was wrong, we did recognize that earlier than others. [Note: BBY shares now trade around $25.] More recently in small cap, we sold Alliant Techsystems [ATK] after concluding we were underestimating the potential severity of defense-spending cuts. The current administration, Congress and the American people dont appear ready to accept the kind of cuts that will be necessary in health and social spending, so
defense may be the whipping boy in this equation. We didnt want to be on the wrong side of that. Critique the handling of your Staples [SPLS] position so far? PE: Our patience is certainly being tested. A few things have kept us from moving on. One, in contrast to Best Buy, Staples has been much more successful in competing online, where it now generates roughly half of its revenue. Two, we believe the company has an obvious lever to pull to increase profitability by getting out of its European retail business. Three, we think its too early to call Staples secularly challenged, given that the cyclical office-products environment remains poor and U.S. white-collar employment has yet to rebound. If white collar employment rebounds and Staples does not, then we have a problem. It is a mature business, but over the long run should still grow modestly and the stock
is highly depressed, carrying a 10% free cash flow yield. Pat, you were a scholarship golfer at Stanford hows your game today? PE: Not great. I need strokes from my 18year-old, the 16-year-old regularly beats me, and it wont be long before my 13year-old does as well. I do think my time playing golf taught me some useful lessons as an investor. For one, you make mistakes all the time and you try to learn from them, but its always about the next shot. Its about properly preparing and then executing to the best of your ability. Thats an excellent mindset for an investor to have. Another thing tournament golf teaches you is resolve. You can have a bad nine holes, or even a bad round, and still win a four-round tournament. If you hang in there, keep your wits about you and dont take undue risks, the end result can turn out quite well. VII
March 30, 2012
I N V E S T O R I N S I G H T : Shawn Kravetz
Investor Insight: Shawn Kravetz

Esplanade Capital's Shawn Kravetz explains his evolving views in areas of focus such as gaming and for-profit education, the types of small and messy situations that attract him, why he's added solar energy to his circle of competence, and why he sees upside in Skechers, MEMC, Ministop and Lakes Entertainment and downside in Wacker Chemie.
You spoke in our last interview [VII, December 30, 2005] about the importance of sticking to ones circle of competence. Have your views evolved on that? Shawn Kravetz: My basic view hasnt changed, which is that an extensive knowledge of a business improves your ability to recognize patterns and draw useful insights, a prerequisite to having an investment edge. Beyond that, Id argue that expertise is critical when things inevitably happen and you either need the conviction to stick with your thesis or the wisdom to recognize that its changed and react accordingly. Stepping outside of areas we know well just seems too much like dancing through a minefield. What were essentially looking for are growth companies, trading at value prices, in which were early in recognizing the future potential and where we believe the marginal economics are even better than people think. We look for those opportunities in industries in which we have deep experience, which are retail/consumer, gaming, education, business services and new since we last spoke solar energy. Last time you described secular growth potential as a key rationale for those industry choices. Is that as true as it once was, say, in for-profit education? SK: Education was our largest sector on the long side in the early years of the fund, was a source of both select long and short opportunities preceding and following the 2008 financial crisis, and is today virtually absent from our portfolio. The industry somewhat recklessly brought in too many students and charged them too much, all with the help of government largesse. Were now well into the retrenchment period which means were finding interesting things to again look at but its
March 30, 2012
going to be a long unwind that will be more secular headwind than tailwind. In a similar context, whats your updated take on gaming? SK: Gaming, particularly for casino operators, is a fabulous business with extremely high returns on invested capital. The recession obviously hit the industry hard, given the high leverage of many of its players and the business overall sensitivity to consumer spending. But gamings fundamental growth drivers of increasing discretionary income and increasing spending on entertainment as incomes rise are very much still intact worldwide. We never believed the industry was immune to cycles, but while the U.S. was struggling, new markets blossomed that have made Las Vegas look almost quaint. Theres a good chance Las Vegas in 2012 will be the third-largest gaming market in the world, behind Macau and Singapore. The growth in Macau has been staggering over the past five years it now generates five times the profits of Las Vegas as a gaming center. Singapore may be even more interesting as a model. It methodically set out to be in the gaming business and believed it could thoughtfully manage and control the process while generating significant revenues for the country. It sold two very expensive licenses one to Las Vegas Sands [LVS], whose stock we own, and the other to Malaysias Genting Group creating a duopoly in a stable, highly attractive market. Analysts were considered incredibly optimistic in estimating that Las Vegas Sands casino there, which opened in 2010, could generate $500 million in EBITDA annually, making it the most profitable casino in the world. That casino today is earning at a run rate of $1.6 billion in annual EBITDA.
Shawn Kravetz
Hands On
Prior to founding Esplanade Capital in 1999, Shawn Kravetz put his Harvard MBA to even more conventional use as a strategic planner and strategy consultant. As he described when last interviewed in Value Investor Insight [December 30, 2005], this initial career training wasn't an obvious plus: This may sound heretical, but consultants are generally not very good investors. You're trained to find the 'right' answer and tend not to acknowledge that your analysis might have been wrong. As an investor, when the market tells you you're wrong, you have to acknowledge that and try to understand why. Kravetz's experience has influenced his hands-on approach to fundamental research: I can't say the extent to which this is unique, but I want to talk directly to people installing solar panels, or buying and selling a certain kind of shoe, or taking classes at night. It's one thing to read a sell-side report or go to a conference, but it's another to understand first-hand how decisions are really being made about the products and services sold by companies in which you want to invest. I want to do that type of thing myself rather than read notes from someone two years out of business school.
Other countries are looking at Singapore as the role model for what to do with integrated casino resorts. We expect over time to see similar developments in South Korea, the Philippines, Vietnam, Japan, Spain and elsewhere, and were investing in companies best positioned to capitalize on that Las Vegas Sands being at the very top of the list. Describe whats behind your focus on solar energy. SK: We started getting interested in solar seven years ago. There were dynamic companies, growing very quickly, with tremendous future market opportunity, but in the U.S. the industry was still viewed as this futuristic, hippie, Berkeley, California type of lark. But in places like Germany and Japan, solar was becoming a way of life. The lack of a home bias made it more compelling as an investment opportunity if you believed the prevailing wisdom was going to be proven wrong. On top of that, the business model was starting to be proven in other countries, companies along the value chain were actually making money, and the prospective market was almost unlimited. It wasnt like in the late 1990s when if you did the math on how many Sun Microsystems servers had to be sold to justify its market cap, you had to believe everyone in the world would have a Sun machine on his desk. We were talking about electricity generation, which truly was a $1 trillion global market, and solar at the time represented less than onetenth of one percent of that. That was seven years ago, when there was roughly one gigawatt of solar-energy capacity installed each year. In 2011, that number was 27 gigawatts installed. Today you have a much more competitive industry that has done what large growth industries tend to do in commodity-oriented markets capacity expands beyond current demand and the profit pool shrinks even while the market continues to grow. That hit home starting in 2010 and accelerated in 2011. We believe 2012 will remain very challenging, but could be a turning-point year for the industry, when prices fall to a level where
March 30, 2012
a lot of excesses get wrung out of the business, solars cost-competitiveness gets stronger, and the industry grows more profitably worldwide while reducing its dependence on overly generous government subsidies. Global revenue for the solar industry last year was on the order of $100 billion, but plenty of investors still dont believe its an actual business, or that anything dependent on government subsidies is investable. That hasnt bothered them in aerospace, or healthcare, or defense, but here its a deal-killer. Because of that disbelief and the fact that the industry is still so young, the extremes get amplified. That gives us more chances to make money.
ON INVESTING IN SOLAR: When people are throwing the baby out with the bathwater, were looking to go long the baby and short the bathwater.
Your timing could have been better in launching a solar-focused fund in mid2009. How has it fared so far? SK: As I mentioned earlier with for-profit education, focusing on a sector doesnt mean you have to be long. Through a combination of solid stock picking and some well-placed shorts, the new fund through the end of last year was up a cumulative 29% net, while representative solar-energy ETFs were down 75% over the same period. In 2011, 58 of the 59 stocks in our core solar coverage universe declined. Its come back somewhat this year, but at the moment investors seem to have largely capitulated on the sector. When people are throwing the baby out with the bathwater, were looking to go long the baby and short the bathwater. Well come back to that later, but returning to the subject of circle of competence, how does a holding like First Republic Bank [FRC] fit?
SK: We consider First Republic a retail business with a superior franchise. Its an upscale retail and commercial bank that does good old-fashioned banking its a relationship business to them, where employees make customers feel like theyre being served by an exclusive private bank. How often do you feel like that with your big dumb bank across the street, where no one knows who you are and doesnt care? This is a company with great economics that is in only six markets in the U.S. It hasnt come close to penetrating those markets, and there are probably another 10 to 20 in which it can expand. We believe it can increase earnings organically at 15%-plus per year for many years. If you looked at this as if it were a retailer, I can assure you it would be deemed worth a lot more than its current 12x earnings multiple. Because its a bank, people think thats expensive. Describe your valuation discipline. SK: The types of things that interest us are sufficiently dissimilar that its hard to generalize. We invest in messy, small-cap situations where we think the net assets are worth at least the current market cap, say, and we have free options on the upside. Lakes Entertainment [LACO] is an example of that well talk about later. At the other end of the spectrum, well also invest in high-quality, large-cap names trading at low multiples of free cash flow because theyre priced as if they will never grow again. Lowes [LOW] and Microsoft [MSFT] are examples we bought last year that have worked out very well. If I had to say, were typically looking for companies that can grow earnings and/or cash flow at low double-digit rates, when their stocks trade at high single-digit or low double-digit P/E multiples based on what we believe they can earn on a forward basis. How concentrated does your portfolio tend to be and why? SK: We typically own around 15 stocks on the long side and 5 or so shorts.
Maintaining that level of concentration is mostly a function of the depth of research I and my colleague Paul Strigler want to do ourselves, which limits the number of ideas we can focus on at a given time. Were only in our absolute best ideas, but arent so concentrated that if we make a big mistake or get hit by something out of left field that the fund will be devastated. A target full long position is about 7%, and were very sensitive to having anything at 10% or more of the portfolio. Turning to a specific solar-energy idea, describe your interest in MEMC Electronic Materials [WFR].
INVESTMENT SNAPSHOT
SK: The company was founded more than 50 years ago and has been a pioneer in the manufacture of silicon wafers, which are the building blocks for semiconductors and, in more recent years, solar panels. The company consists of three main parts. The traditional semiconductorwafer business is currently in a tough part of its cycle and while I wouldnt call it a great business, the competitive environment and MEMCs position in it make it a decent business over the course of a full cycle. It loses money at the bottom and makes a lot of money at the top. On a mid-cycle, normalized basis it earns on
MEMC Electronic Materials

(NYSE: WFR)
Valuation Metrics
(@3/29/12):
Business: Development, manufacture and sale of silicon wafers used to make semiconductors. Two primary business lines are Semiconductor Materials and Solar Energy. Share Information
(@3/29/12):

(@12/31/11):
WFR n/a 21.7
Russell 2000 42.2 20.2
Price
Financials (TTM):
3.69
3.50 13.18 0.0% $851.6 million $2.72 billion (-0.9%) (-56.6%)
Company Thornburg Inv Mgmt Vanguard Group Luminus Mgmt Proxima Capital Altai Capital
% Owned 10.9% 4.7% 4.4% 2.7% 2.7% 9.4%

25 20 15 10 5 0

WFR PRICE HISTORY 25 20 15 10 5 0
Shares Short/Float
the order of $150 million to $200 million in annual EBITDA. The second main business is selling polysilicon wafers to solar-panel manufacturers. This drove massive profit and share-price gains from 2005 to 2008, but the business has collapsed under the weight of global overcapacity and remains under immense pressure. The company is rationalizing capacity, but in our opinion this product line should be sold for whatever they can get or shut down. The third business is SunEdison, which plans, constructs, manages and often owns part of large-scale solar installations for corporations, independent power generators and utilities. This is a very different business for MEMC, focused on long-lived assets with longlived earnings streams, and we consider it an underappreciated jewel. It is a prime beneficiary of falling prices for solar panels and components fueling robust demand particularly in growing parts of the world and it has a development pipeline that should produce more than $1.5 billion worth of projects this year. Some of the projects SunEdison does are comparable to the solar power plants Berkshire Hathaways MidAmerican Energy division invested $3 billion in a few months ago. These are high-quality assets on which owners can make a good return. Thats further confirmation to us of the long-term viability of solar as an industry. We take it you believe the sum-of-theparts value here exceeds the current $3.70 share price, which is at a 10-year low. SK: The company has disappointed from an execution and stock-price standpoint for years now and overspends on corporate overhead, so we do believe its worth considerably more apart than together. There are two very good assets here (the solar-wafer business may have value to an acquirer, but were valuing it at $0). The semiconductor business would be an attractive asset for another large player in the industry and we believe is worth $2.75 to $3.50 per share, based both on replacement value and by applying a reaValue Investor Insight 12
2010
2011
2012
THE BOTTOM LINE
By focusing on the highly cyclical and currently depressed parts of the companys business, the market is missing the significant value in SunEdison, its jewel solarproject development operation, says Shawn Kravetz. Arguing that the company should be broken up, he puts a sum-of-the-parts value on its shares of around $8.
March 30, 2012
sonable 3.7x to 4.7x multiple to normalized annual EBITDA of $175 million. Im not convinced SunEdison even as a pure play should be publicly traded, given its capital intensity and the lumpiness of its results. But it would likely be highly coveted by large energy companies looking to expand their downstream solar pipeline and capability. Frances Total, for example, recently bought a majority stake in SunPower, one core asset of which is its development business. If you valued SunEdison at 7x our 2012 EPS estimate for it, or at 3.2x our 2012 EBITDA estimate, its worth around $5 or so per MEMC share. That gets us to a base-case fair value thats roughly twice todays stock price. Given the size and growth of the solarproject development pipeline, we think thats potentially very conservative. This is the largest solar position we own today. Has management shown any inkling that theyre on the same page? SK: Unfortunately, no, but I dont consider that a big negative. The market clearly hasnt embraced the status quo. That message is likely to get through eventually, one way or another. On the bathwater side of your portfolio, explain why youre short Wacker Chemie [WCH:GR]. SK: Our shorts today are highly concentrated in one part of the solar value chain, the makers of polysilicon used to manufacture solar panels. For years this was a great business dominated by a tight oligopoly including Wacker, Dow Cornings Hemlock, Tokuyama of Japan and, to some extent, MEMC Electronics. But the growth of the industry has led to structural overcapacity that is so pronounced Chinas GCL-Poly and South Koreas OCI will in the next year overtake Hemlock and Wacker as the largest polysilicon manufacturers in the world that we expect profits to fall well short of even reduced expectations in 2012. Prices for polysilicon, which costs $20-30 per kilogram to make, were around $80 per kilo
March 30, 2012
less than a year ago. Today they barely cover the cost and we think are more likely to go lower than higher. How tied is Wacker to that business? SK: In 2011 polysilicon accounted for two-thirds of the companys 1.1 billion in EBITDA. Management has guided to materially lower EBITDA this year, but the consensus estimate for the company overall is still around 900 million. We believe a shortfall in polysilicon will make that come in closer to 600 million. Because of the huge fixed investments the company has made in recent years to expand polysilicon capacity, net income may be close to breakeven. But consensus 2012 analyst estimates for the company are still for earnings of 4-5 per share.
INVESTMENT SNAPSHOT
The rest of Wackers business, also currently struggling, may be able to offset some of the shortfall in 2013 and beyond, but we dont consider this year to be a one-year hiccup on the polysilicon side. Its more of a resetting of how this business is going to look for them in the future. Youve written about the importance of catalysts on the short side. Is this years expected earnings shortfall a good example of one? SK: We love to have catalysts in our longs, but if you own the right kind of company, with the right kind of balance sheet and you paid the right price, you can wait for the thesis to evolve. In shorts you can get killed waiting for something
Wacker Chemie
(Xetra: WCH:GR)
Business: Global producer of specialty chemicals, including polysilicon for the electronics and solar industries, silicones and vinyl acetate-based polymers. Share Information
(@3/29/12, Exchange Rate: $1 = 0.752):
Financials (TTM):
Revenue EBIT Margin Net Profit Margin

Valuation Metrics
4.91 billion 12.3% 7.3%
Price
WCH PRICE HISTORY 200
66.06 56.87 175.50 4.8% 3.45 billion
P/E
WCH 9.3
S&P 500 16.2
200
150
150
100
100
50
2010
2011
2012
50
THE BOTTOM LINE
The engine of the company the manufacture and sale of polysilicon to the solarenergy industry is more irreparably damaged than the market seems to realize, says Shawn Kravetz. Using his estimates for this year, at what he considers a reasonable 5x EV/EBITDA multiple, the companys shares would trade at closer to 50.
to happen, so we put much more emphasis on having a catalyst. Despite other decent assets, solar polysilicon is the engine of this company. If prices stay where they are or go lower, the impact on the reported numbers will force people not only to take down estimates meaningfully for this year, but also to reset expectations for the future. Thats a clear catalyst. The shares have already taken a significant drubbing over the past several months. What downside do you see from todays price of 66? SK: A 5x EBITDA multiple is a reasonable valuation for a fine company whose core business engine will continue to struggle. On our estimates for this year, that translates into a share price of around 50. Id add that were also short Tokuyama [9946:JP] for all the same reasons. Its smaller than Wacker, so is even more vulnerable because it lacks relative scale and diversification. Its stock is down sharply as well, but expectations are still far too high. We prematurely, as it turns out covered the turnaround case for Skechers [SKX] nearly a year ago [VII, May 27, 2011]. Whats your take on it today? SK: This is a solid footwear company that has a knack every few years for identifying and milking a super-hot product. Unfortunately for them, the last time they did it with so-called toning sneakers the market collapsed as quickly as it grew and caught them with far too much inventory worldwide and more overhead than necessary. Even as the stock got cut in half to the low $20s a year ago, we avoided it because the company was still too far away from getting out from under the problem. Now that the comparisons with the toning-shoe boom times are rolling off, we think the timing and valuation are much more attractive. While theres clearly a faddish element to what the company does, its built a recognizable brand in casual, affordable
March 30, 2012
footwear for the entire family, with excellent distribution through its nearly 330 company-operated stores as well as through many of the best department and specialty stores. It regularly develops new products, including an emphasis today on expanding its fitness offerings under the GOrun name. Our basic premise is that the toningrelated problems have obscured what is actually a strong and enduring consumer retail business, with high incremental margins as it grows through store expansion in the U.S. and increased distribution outside the U.S. If we look out to 2013, were estimating around $1.6 bilINVESTMENT SNAPSHOT
lion in revenue, with 7-8% EBITDA margins, earnings per share of close to $1, and net cash on the balance sheet pushing $5 per share. How do you see that translating into share upside from todays price of $12.80? SK: If our 2013 numbers turn out to be right, the company will have objectively started to turn the corner and should easily command a 15x earnings multiple. Adding in the estimated level of net cash, that would result in a share price of around $20.
Skechers
(NYSE: SKX)
Valuation Metrics
(@3/29/12):
Business: Designs, markets and sells casual footwear for men, women and children, sold primarily through independent retailers and company-owned stores. Share Information
(@3/29/12):

(@12/31/11):
SKX n/a n/a
Russell 2000 42.2 20.2
Price
Financials (TTM):
12.81
11.21 21.47 0.0% $640.4 million $1.61 billion (-5.4%) (-4.2%)
Company Fidelity Mgmt & Research Artisan Partners Wellington Mgmt Pzena Inv Mgmt Vanguard Group
% Owned 15.7% 8.0% 7.0% 6.3% 5.0% 19.5%

50 40 30 20 10 0

SKX PRICE HISTORY 50 40 30 20 10 0
Shares Short/Float
2010
2011
2012
THE BOTTOM LINE
Getting out from under its overplayed bet on so-called toning shoes has proven more painful than expected, but the company still has a strong and enduring consumer retail business, says Shawn Kravetz. Adding in excess cash, at 15x the $1 per share he believes the company can earn in 2013, the shares would be worth around $20.
And that would be before anything particularly good has happened. The company made $2.80 per share in 2010 during the toning boom and, more importantly, had prior to last year been above $1 in EPS since 2005. Its not as if our $1 estimate for 2013 is pushing uncharted territory. One open question is whether theyll do anything with the balance sheet. We dont expect a dividend anytime soon, but do think a share buyback is possible once legal and regulatory contingencies are resolved over advertising claims for the toning shoes. Theyve already reserved $45 million against such costs, but will likely look for more clarity on the ultimate exposure before returning any cash to shareholders. What attracted your attention in Japanese convenience-store operator Ministop [9946:JP]? SK: In the aftermath of last years earthquake and Fukushima nuclear disaster we spent a lot of time looking for potential investment opportunities in Japan. Wed done very little there, concerned that the markets reputation for cheap stocks that stay that way forever was more or less deserved. A fellow investor we respect told us he was looking at the convenience-store market in Japan, which struck a chord because we were already looking for ideas there and we know the convenience-store business in general quite well. As it turns out, we came upon three similar companies in the industry Ministop, Circle K Sunkus [3337:JP] and FamilyMart [8028:JP] which were just too cheap too ignore. While weve made some money particularly in Circle K Sunkus, which has accepted a buyout offer from Uny, its majority owner the crux of the story here is how inexpensive Ministops shares are. At todays share price [of 1,580], the stock trades at roughly 2x EBITDA on an enterprise value basis, and at 70% of what is a rock-solid book value. Nearly 30% of the market cap is in cash. The stock is so cheap youd expect to find
March 30, 2012
financial risk or a business moving decidedly in the wrong direction, neither of which is at all the case. Is the business growing? SK: The Japanese market has little to no growth, but the company continues to benefit from the economic recovery since the earthquake and tsunami same-store sales, revenues, and profits in Japan are now moving in the right direction. Roughly half of Ministops 4,200 stores are outside of Japan, mostly in South Korea but also with a small but growing presence in China. For the company overall, annual top-line growth is likely to be in the 3-5% range nothing remarkable, but much better than what appears to be priced into the shares.
INVESTMENT SNAPSHOT
What do you believe the shares are more reasonably worth? SK: Ministop is in a strikingly similar situation to Circle K Sunkus, with a majority stake held in it by a larger retailer called Aeon. At the price Uny is paying for Circle K Sunkus, 1.1x book value, Ministop shares would go for around 2,200. Were not counting on it becoming a takeover candidate, but it wouldnt surprise us the industry is likely to continue to consolidate as retailers try to increase scale in a flattish market. Absent any M&A, part of the joy in buying dirt-cheap companies for which there are exceedingly low expectations is that it doesnt take much for things to look up. If momentum turns even slightly better and the multiple moves from 2x
Ministop
(Tokyo: 9946:JP)
Business: Owns and operates more than 4,000 combined convenience and fastfood stores in Asia, the large majority of which are in Japan and South Korea. Share Information
(@3/29/12, Exchange Rate: $1 = 82.42):
Financials (TTM):
Revenue EBITDA Margin Net Profit Margin

Valuation Metrics
122.55 billion 12.2% 2.5%
Price
1,578 1,263 1,580 2.8% 46.35 billion
P/E
Ministop 14.2
Russell 2000 42.2
MINISTOP PRICE HISTORY 1750 1500 1250 1000 750
1750 1500 1250 1000 750
2010
2011
2012
THE BOTTOM LINE
Shawn Kravetz argues that while the bare-bones valuation on the companys stock would imply either severe financial distress or a business moving decidedly in the wrong direction, neither is at all the case. At the still-low multiple of book value at which a primary competitor is being taken private, the shares would trade at 2,200.
EBITDA to maybe 2.5x, well make pretty good money. Describe one of your most off-the-grid ideas, Lakes Entertainment. SK: This is one of the smaller-cap investments weve made in a long time. The company has been involved over the years in a motley crew of gaming-oriented businesses, from owning the World Poker Tour to developing and managing various Indian-tribe casinos around the U.S. It tends to throw a lot against the wall, some of which sticks and some of which doesnt. Thats not exactly our typical recipe for developing long-term sustainable value, but it is what it is. The company at the moment has no real operating assets, which is why the financials look terrible overhead costs and not much else. The primary value we see resides in an 8% economic interest in Rock Ohio Ventures, a partnership between Caesars Entertainment and Dan Gilbert, who founded Quicken Loans and owns the Cleveland Cavaliers. Rock Ohio has been approved to open two new casinos in Ohio in Cleveland and Cincinnati with local monopolies. Clevelands is slated to open on May 15, with Cincinnatis not due until sometime in early 2013. While theres no direct comp for either new casino, we can estimate run-rate EBITDA for each based on experiences elsewhere, corrected for the size of the market, make-up of the casino, etc. For Cleveland, we estimate EBITDA reaching nearly $100 million, which at a 7.5x multiple would translate into about $2 per share of value in Lakes. The Cincinnati casino will be smaller, but we estimate the value of it to Lakes at around $1 per share. On top of that the company currently has nearly $40 million in net cash, which is 80% of the current market cap. Some of that will be drawn down to pay for Lakes share of further investment in Rock Ohio and to pay off some other previous obligations, but we believe there will be roughly $1 per share in cash left when all is said and done.
March 30, 2012
Youre already ascribing value that is well above the current share price of $1.80. Are you finding any other options on the upside? SK: This is even more speculative, but Lakes should hear soon whether its been approved to operate a mostly gamingmachine operation at the Rocky Gap Lodge & Golf Resort in Cumberland, Maryland. The company is the last remaining candidate in the running, but Maryland may still decide not to grant this particular license. If it does, we think this operation could be worth another 50 cents to $1 per share.
INVESTMENT SNAPSHOT
Finally, Lakes also has notes receivable from previous contracts with various Indian tribes for which payments have been suspended. These have mostly been marked down to zero, but there is a possibility they could generate future proceeds. If things went very well, that could mean another $1 per share in value. As risky as some of the payoffs might be, we like that we have multiple ways to win here. If Cleveland launches to even modest success, that asset and the cash should allow us to at least get our money out. If just Cleveland does well, we should be very happy as investors. If other things go right, well be ecstatic.
Lakes Entertainment
(Nasdaq: LACO)
Valuation Metrics
(@3/29/12):
Business: Develops, owns and manages typically with partners casino or other gaming-related properties. Primary asset today is interest in two new Ohio casinos. Share Information
(@3/29/12):

(@12/31/11):
LACO n/a n/a
Russell 2000 42.2 20.2
Price
Financials (TTM):
1.81
1.76 2.84 0.0% $47.9 million $35.6 million 39.6% (-5.2%)
Company Dimensional Fund Adv Par Capital Morgan Stanley T. Rowe Price Hotchkis & Wiley
% Owned 6.4% 5.0% 3.8% 3.6% 2.5% 0.1%

5 4 3 2 1

LACO PRICE HISTORY 5 4 3 2 1 2010
Shares Short/Float
2011
2012
THE BOTTOM LINE
Ascribing value to the companys assets other than its large cash holding is clearly a speculative enterprise, but the risk/reward profile that results is quite compelling, says Shawn Kravetz. Focusing just on its cash and an interest in two approved casino projects in Ohio, he pegs the value of the companys stock at roughly $4 per share.
We spoke before [VII, October 31, 2007] about another small, quirky idea, Archon Corp. [ARHN.PK], that probably hasnt worked out so well. Any lessons there? SK: We got involved when the stock was trading at a meaningful discount to a single agreed-upon deal it had to sell 27 acres of land on the Las Vegas Strip for approximately $17 million per acre. We knew there was real risk the deal wouldnt close, but thought the reward if it did was worth the risk. After the 2008 crisis hit, the deal fell apart and so did the stock price. We have remained shareholders, however, because weve always felt the intrinsic value of the companys assets even after markdowns far exceeded the market value. Today it offers as good a risk/reward as we have in the portfolio. Explain that. SK: Other than the land on the Strip, there are three primary pieces to the puzzle, all relatively easy to value: corporate
overhead, an office building in Dorchester, Massachusetts and another office building in Gaithersburg, Maryland, which theyve agreed to sell to the current tenant. Quite simply, we believe the value of those three items exceeds Archons current market value of around $64 million. That means the market is ascribing negative value to the vacant land on the Strip. Its difficult to value Las Vegas Strip real estate today. I know its not worth the $15-20 million per acre being paid for comparable land pre-crisis. I know its not worth less than $0. If the company offered it to me for $0, Id take it and Im totally serious would create the worlds most profitable RV and trailer park. It would be a gold mine in the shadow of Wynn Encore and the Fontainebleau Resort. That I could do that indicates its worth more than nothing. With just under six million shares, every $1 million per acre in value for the Strip land is worth roughly $3 per Archon share. At $4 million per acre, youre more
than doubling the current stock price [of $11]. As long as that kind of math remains intact, well be patient. Do you have any general words of wisdom to impart about mistakes? SK: We do post-mortems on all of our positions as well as regular position reviews of what we own to constantly assess what we got right and what we didnt. That matters because we want to learn from mistakes even if the investment outcome turned out fine because we were lucky. Luck is not a sustainable way to make money as an investor. Avoiding mistakes that youve made before is. One primary virtue of experience is that youre constantly learning the ways in which things can go wrong. If you internalize that into your process, youre identifying more of what can go wrong and assessing how that changes your investment case. Minimizing the number of times you get blindsided is a very worthy goal. VII
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March 30, 2012
U N C O V E R I N G V A L U E : Poseidon Concepts
Full Tank
A recent spinoff that has yet to publish its first quarterly financials, Poseidon Concepts sports a decidedly low profile with investors. Based on its growth potential in a booming market, that is likely to change.
There's an old saying that the better business in a gold-rush-type market is to sell pickaxes rather than to own mines. The analogy is apt in contemplating the potential of Poseidon Concepts, a Calgary-based lessor of tanks used to collect and manage water and related fluids at well sites where hydrofracturing, or fracking, is used to extract oil and natural gas. Relative to the incumbent methods for managing water at non-conventional wells lined open pits and linked tank farms using 400-barrel capacity tanks Poseidon's modular tanks, with capacities ranging from 4,500 to 41,000 barrels, offer drillers superior economic and environmental attributes, says Longbow Capital's Terry Fitzgerald. A conventional tank farm may require 100 to 150 tanks, each needing one 18-wheeler per tank for transport, causing the set-up and take-down processes to each take roughly four days. Even the largest Poseidon tank can be installed or removed in one day, transported by two 18-wheelers. The extent of the cost savings? In a recent investor presentation, Sand Ridge Energy put the total savings of using a new Poseidon system at one of its seven-well Mississippi Line sites at $58,000 per well. Sand Ridge expects to drill at least 200 wells in that area this year, suggesting annual savings of more than $10 million from using Poseidon tanks. While the cost savings versus lined pits are smaller, the environmental advantages of the company's systems are pronounced. It says its tanks have so far supported more than 1,000 fractures without an environmental or safety incident, and Poseidon tanks make it easier to treat water on-premises prior to reintroducing it into ground water or recycling it for further use. Lined ponds have proven more prone to leakage and are particularly vulnerable in floods. Citing such concerns, the North Dakota legislature earliMarch 30, 2012
er this month sharply restricted the use of such pits at most drilling sites in the state. While fracking as a method for oil and gas extraction is growing, Longbow's Fitzgerald ties Poseidon's near-term upside primarily to taking share from existing water-management methods. He says roughly 50% of the fracking done today in North America relies on lined ponds to hold water, and in most cases Poseidon can offer a better alternative. Of tank-based storage currently in place, he says the company now has only about 7% of the addressable market. We are
INVESTMENT SNAPSHOT
not basing our thesis on an extrapolation of growth in hydrofracturing, he says. We expect fracking will continue to grow and that represents an incremental positive, but the real story is that Poseidon provides a superior disruptive solution that is disintermediating the current alternatives. Poseidon's rental business model is as simple as it is lucrative. The company outsources nearly everything and currently has less than 50 employees. As demand for its systems takes off, Fitzgerald expects a very high percentage of the
Poseidon Concepts
(Toronto: PSN:CN)
Business: Leases modular tank systems used to manage water and related fluids that are used in the hydrofracturing method for extracting natural gas and oil. Share Information
(@3/29/12, Exchange Rate: $1 = C$0.997):
Financials (Est. 2012):

Valuation Metrics
(Current Price vs. TTM est.):
C$248.0 million 83.1% 58.5%
Price
PSN PRICE HISTORY 20
C$13.88 C$10.05 C$16.90 7.8% C$1.13 billion
P/E
PSN n/a
Russell 2000 42.2
20
15
15
10 2010 2011 2012
10
THE BOTTOM LINE
The companys superior disruptive solution for managing water and other fluids used in non-conventional oil and natural gas drilling positions it exceedingly well to take market share at North American wells, says Terry Fitzgerald. At a 6.5x EV/EBITDA multiple on his 2013 estimates, his one-year price target for the shares is C$22.50.
U N C O V E R I N G V A L U E : Poseidon Concepts
spoils to fall to the bottom line. Assuming an average 400-tank fleet in place, average $2,400-per-day rental rates and utilization levels of around 70%, he believes the company can generate nearly C$250 million in revenue in 2012, earn an 80% EBITDA margin and generate C$145 million in net income, roughly C$1.80 per share. Even as inevitable competition brings day rates and margins down, he's still expecting high volume growth to result in some C$340 million in 2013 revenue and C$2.30 per share in earnings. What's that worth to equity holders? The company's stock remains well off most investors' radar screens. Poseidon was spun off in November by exploration and production company Open Range Energy, so has yet to publish its own independent quarterly financials and is followed in the U.S. by only one boutique research firm. On Fitzgeralds 2013 numbers, at the current price of C$13.90, the stock trades at an EV/EBITDA multiple of 4.2x. That's at the very low end of the valuation range for companies in the more generic and highly competitive oilfield-services sector, he says, and a signif-
icant discount to more comparable specialized oil-services firms, which trade at 7-9x EV/EBITDA. At the 6.5x multiple he thinks is reasonable for Poseidon, the shares would trade at C$22.50. In the meantime, the company is debt-free and is able to fund its projected growth from
ON COMPETITION: New entrants will likely focus more on industry growth and taking share from incumbents than pounding on price.
internally generated cash flows while retaining the ability to pay a healthy C$1.08-per-share annual dividend, resulting in a current 7.8% yield. The biggest risk to that rosy outlook is competition. Firms don't make 80% EBITDA margins without attracting competitive notice, and while Poseidon enjoys certain first-mover advantages including hard-won existing relationships with
more than 100 customers and a highly valued environmental and safety record its systems are not so sophisticated from an engineering standpoint that they can't be replicated. Due to new competition, Fitzgerald expects rental day rates for the company to fall 20% in 2013, crimping EBITDA margins but still leaving them at a sky-high 77%. That's largely because he believes new entrants will be more focused on taking advantage of fracking growth and on taking share from incumbent water-management alternatives than on pounding Poseidon on price. Offsetting some of that risk is incremental upside if utilization rates of Poseidon's tanks come in better than expected. Fitzgerald is modeling around 70% usage rates for 2012 and 2013, but believes there's potential for those to be much higher, which would have a significant positive impact on earnings. If utilization rates came in at 80% in 2013, for example, his EPS estimate would be more than 25% higher, pushing C$3. Our base-case twelve-month target price of C$22.50 is not the limit of the opportunity here, he says. VII
Your Guide Through Perilous Seas

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March 30, 2012
U N C O V E R I N G R I S K : Diamond Foods
In the Rough
Investment cases could be made that Diamond Foods is: 1) An ongoing train wreck, or 2) A compelling contrarian bet. Solas Capitals Tucker Golden explains why he suggests bargain hunters steer far and wide.
Committed investment contrarians could find Diamond Foods worth a look. The seller of branded snack foods such as Emerald nuts, Pop Secret popcorn and Kettle potato chips has seen its share price fall 76% in the past six months, to a recent $23.20. Disclosed accounting irregularities around payments made to nut growers scuttled what would have been a crowning-achievement deal the purchase of P&G's Pringles led to the February ouster of the company's CEO, prompted SEC and Justice Department investigations, and have left the company scrambling to repair its over-extended balance sheet. After announcing a deal last week with certain creditors that increased Diamond's interest costs and required it to eliminate its dividend, the stock fell more than 7% the next day. A case in which things look darkest before the dawn? In a word, no, says Solas Capital's Tucker Golden. He and partner Anand Atre have a long and sometimes painful history with the company's stock, having made the short case for it two years ago in Value Investor Insight [January 29, 2010] at around $37. Diamond then seemingly proceeded to go from strength to strength, buying Kettle in February 2010, regularly reporting earnings surprises, and then in April 2011 announcing the proposed $2.35 billion Pringles buy, a deal to be paid for mostly by selling ever-more-valuable new equity. In September 2011 Diamond shares hit an all-time high of $96. Then the roof caved in. The company last November announced an internal audit investigation, a board member on the audit committee died by suicide, and the market priced into the stock that the Pringles deal was likely dead. Golden and Atre, having stuck with their short position even selectively adding to it on the way up closed out their position at around $27. Painful as it was, at every step of the way our fundamental analysis
March 30, 2012
had implied a value far below the stock price, says Golden. With a chance the Pringles deal still might close, at $27 that was no longer the case. What is Diamond worth today? Golden pegs the value of the profitable Kettle business at up to 10x EBITDA, or $700 million. Pop Secret has done fairly well since being purchased for $190 million in 2008, but because he believes Diamond egregiously overpaid for it, he'd be surprised if it could fetch more than $200 million. He ascribes no value
INVESTMENT SNAPSHOT
to the nut franchise because he believes its burning cash and fighting to retain its suppliers. After some $610 million in estimated net debt, that leaves roughly $13 per share in equity value, 45% below the current price. That takes no account of an estimated $100 million final payment due this summer to walnut growers for last year's crop, potential fines, lawsuit settlements, increased advisory fees, or the possibility of a dilutive capital raise, says Golden. His fund is again betting against Diamonds stock. VII
Diamond Foods
(Nasdaq: DMND)
Business: Markets nuts and packaged snack foods under the Kettle, Pop Secret, Diamond of California and Emerald brands. Share Information (@3/29/12):
Valuation Metrics
(@3/29/12):

(@12/31/11):
DMND 10.4 7.2
Russell 2000 42.2 20.2
Price
Financials (TTM):
23.17
21.41 96.13 0.0% $510.9 million $965.9 million 11.4% 5.2%
Company Fidelity Mgmt & Research Wellington Mgmt Columbia Wanger Asset Mgmt
% Owned 14.0% 12.3% 6.1% 64.6%

100 80 60 40 20

DMND PRICE HISTORY 100 80 60 40 20 2010 THE BOTTOM LINE
Shares Short/Float
2011
2012
Faced with unhappy suppliers, an over-extended balance sheet and the overhang of SEC and Justice Department investigations, the company is not one on which to take an investment flier, says Tucker Golden. His estimate of fair value per share: $13.
S T R A T E G Y : Zeke Ashton
Building a Robust Investing Strategy

Having identified the five key factors that traditionally lead to catastrophic investor failure, Centaur Capitals Zeke Ashton in this essay details how he addresses each in managing his highly successful investment partnership.
Editors Note: In addition to delivering market-trouncing returns since founding Centaur Capital in 2002, Zeke Ashton [VII, April 30, 2010] has also established himself through his investor letters and the occasional essay as an introspective and articulate student of the craft of investing. In these excerpts from a recent Centaur Value Fund [CVF] letter, he outlines the essential elements of a built-tolast investing strategy. One of the realities of investing that we need to acknowledge is that we are limited in our ability to predict the future, and therefore we cannot reasonably hope to be perfectly positioned for whatever the prevailing environment may be in a given time horizon. Each year brings unforeseen events, some positive and some negative, and even companies that we have come to understand well can often surprise us. If we cant know in advance with any precision what kind of investing scenario we may face in any given year, it makes sense to develop a strategy that can be expected to do reasonably well across the widest possible number of potential scenarios what a game theorist might call a robust strategy. This requires that the strategy be able to overcome not only occasional bear markets and dislocations, but all of the other hurdles that are endemic to active management. The list includes bad luck, bad timing, and occasional mistakes in judgment or execution. Most importantly, any truly robust longterm investing strategy must be built to survive the worst possible scenarios the market can throw at us and live to play another day. The only major drawback for the truly robust strategy is that it is highly unlikely to be the best performer in any given scenario or environment. In fact, one of the hallmarks of a robust investing strategy is that it must actively work to eliminate extreme results both
March 30, 2012
positive and negative. While it is not always easy to endure those periods where more aggressive strategies appear to be making money hand over fist, it seems a reasonable trade-off given the long-term benefits offered by the more resilient strategy. Avoiding Common Pitfalls Charlie Munger, who is best known for his role in collaborating with Warren Buffett to build the exceptional longterm track record at Berkshire Hathaway, offers a useful mental exercise for accomplishing any complex task. His technique is to first invert the problem by identifying the common pitfalls that one wishes to avoid and then building in plans specifically to prevent the classic causes of failure. It is for this reason that we have made a practice of studying the reasons that investment funds or strategies fail, looking for lessons that we can incorporate to make our own strategy more robust. In almost every case of catastrophic failure that weve observed, we believe the root cause can ultimately be boiled down to one or a combination of just five factors. The five factors are 1) leverage; 2) excessive concentration; 3) excessive correlation; 4) illiquidity; and 5) capital flight. Having identified these five factors most commonly implicated in investing strategy failure, we have worked to address each of them to help us to avoid these common pitfalls or otherwise minimize their impact. Leverage Excess leverage is one of the classic causes of investment failure. Warren Buffett once observed that leverage is the only way a smart guy can go broke. You do smart things, you eventually get very rich. If you do smart things and use leverage and you do one wrong thing
along the way, it could wipe you out, because anything times zero is zero. While we occasionally use instruments that offer us the benefits of leverage, these instruments are chosen because they offer us leverage to good outcomes but limit our exposure to bad outcomes. We will never use excess leverage to try to enhance our returns in the Fund. Our maximum long exposure is 125% of Fund assets, which takes into account the leverage embedded in any options or other derivative instruments. While the Fund is likely to carry long exposure in excess of 100% of assets for extended periods, the true net exposure to the market is rarely much higher than 75-80% when taking short positions and hedges into account. The highest month-end level of recorded net market exposure for the Fund was a bit higher than 86% of assets, which occurred in late 2008. Excess Concentration Excess concentration is another common factor in investment failures. We have seen many talented managers suffer significant and permanent capital loss due to overconfidence in one or two ideas. While we manage a fairly concentrated portfolio by conventional standards, we also limit individual position sizes in order to prevent a single bad outcome from wiping out our capital. Centaur Value Fund [CVF] often has as much as 40% of its assets invested in the Funds ten largest positions. We believe this level of concentration represents a reasonable compromise between ensuring our capital resides in our best ideas without risking a loss too large to recover from if we suffer a bad outcome in one or two of our top ideas. Correlation While this factor has some similarities to excess concentration, correlation is a
S T R A T E G Y : Zeke Ashton
factor that can sneak up on a manager. This is particularly the case with so-called specialist or sector strategies limited to a narrow universe of potential investments. Such strategies tend to be quite attractive theoretically, as they offer the investing edge of having specialized knowledge, but they are also highly susceptible to systemic shocks impacting the area of specialty. Whether it be the Internet funds that proliferated in the late 1990s before being wiped out by the tech crash in 2000, or master limited partnership funds that suffered terrible losses in the wake of the Lehman Brothers bankruptcy in 2008, owning an entire portfolio of securities that react in a highly correlated fashion to any given risk factor is simply not consistent with a truly robust strategy. This is why we prefer to be generalists and prefer to invest across industries, market caps, and geographies in our search for undervalued securities. This wide-ranging approach generally results in our owning a portfolio of highly idiosyncratic ideas, and also ensures that we can migrate to whatever areas of the capital markets appear to offer the most value at any given time. It is also why our strategy includes the use of short-selling and hedges in the portfolio, as those positions should be negatively correlated to our long portfolio. Finally, we use sector limits as a way to reduce the negative impact of any industry-specific or thematic risk factor. Illiquidity The inability to sell when one wishes to or needs to can often lead to significant losses when an external event requires the sudden need for cash. Given that we deal almost exclusively in publicly traded securities for which there is an active market, CVF is not at great risk from illiquidity. However, we do limit the securities we hold that have limited trading volume that would likely move the stock against us if we were motivated to sell quickly. For our purposes, any security that would likely require more than ten trading days for us to liquidate our entire position
March 30, 2012
(assuming we represented no more than 20% of average daily trading volume) is designated as low liquidity. We limit such investments as a whole to no more than 30% of the funds assets. Theoretically, this would allow us to be able to exit the vast majority of our positions with minimal price disruption over the course of a single calendar month. We limit the holdings of securities that are totally illiquid, such as restricted securi-
ON SPECIALIZATION: Such strategies tend to be quite attractive theoretically, but are also highly susceptible to systematic shocks.
ties or private placements, to a maximum of 10% of Fund assets, and this group is included under the 30% rule noted above. As of this writing, securities meeting the limited liquidity definition comprised approximately 25% of Fund assets, of which approximately 3% are currently restricted from re-sale or are otherwise illiquid. Overall, whether driven by opportunity or necessity, the Funds investments are highly liquid and we remain well guarded against liquidity risks even in an extreme scenario. Capital Flight The final common cause of fund or strategy failure is capital flight, which almost always happens in concert with one of the risk factors noted above. Sometimes the capital flight causes or exposes one of the other risk factors, and sometimes one of the other risk factors causes the capital flight. Either way, the flight of capital will inevitably exacerbate whatever other problems there might be in times of stress. Often, the strategy itself would eventually have fully recovered but for the need to liquidate positions during a time of market dislocation. As noted investor Howard Marks has said, managers need to ensure they build their portwww.valueinvestorinsight.com
folios and funds to survive the worst possible day, otherwise they will end up like the 6-foot-man who drowned crossing a river that was five feet deep on average. You have to be able to get through the low points. Regardless of the strategy, it is inevitable and universal that periods of poor performance will result in some capital-base declines. Given that every strategy will occasionally suffer such periods, modest turnover in the capital base should be expected and planned for. One of the ways to reduce capital flight risk is make every effort to qualify investors who understand the Funds strategy, have realistic expectations, and share a long-term investing horizon. Another method is to avoid excessive concentration of the capital base such that a handful of large investors do not represent the majority of the capital. In the Centaur Value Fund, we are limited to 99 investors by SEC regulations. Most of our investors have been with us for many years, and have participated in the Funds historical track record. No single investor in the Fund comprises greater than 10% of the Funds assets. In addition, approximately 13% of the Funds assets belong to minority owners of the Funds management company. A Strategy for the Long Run As the saying goes, investing is a marathon and not a sprint. And like a marathon course, there are downhill stretches where the going is easy and uphill stretches where the going is hard. Unlike a marathon, however, there isnt a defined finish line, and we must remain diligent as long as we have capital at risk. We hope that this letter has demonstrated that we have given much consideration to building a strategy that can withstand the toughest stretches the course has to offer in order to experience the satisfaction that comes with achieving long-term success. VII
Note: Zeke Ashton is also the manager of the Tilson Dividend Fund [TILDX], in which coEditor Whitney Tilson has an ownership interest.
General Publication Information and Terms of Use
Value Investor Insight and SuperInvestor Insight are published at www.valueinvestorinsight.com (the Site) by Value Investor Media, Inc. Use of this newsletter and its content is governed by the Site Terms of Use described in detail at www.valueinvestorinsight.com/misc/termsofuse. For your convenience, a summary of certain key policies, disclosures and disclaimers is reproduced below. This summary is meant in no way to limit or otherwise circumscribe the full scope and effect of the complete Terms of Use. No Investment Advice This newsletter is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. This newsletter is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financ ial situations, or needs of individual investors. The price and value of securities referred to in this newsletter will fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of all of the original capital invested in a security discussed in this newsletter may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Disclaimers There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth in this newsletter. Value Investor Media will not be liable to you or anyone else for any loss or injury resulting directly or indirectly from the use of the information contained in this newsletter, caused in whole or in part by its negligence in compiling, interpreting, reporting or delivering the content in this newsletter. Related Persons Value Investor Medias officers, directors, employees and/or principals (collectively Related Persons) may have positions in and may, from time to time, make purchases or sales of the securities or other investments discussed or evaluated in this newsletter. Whitney Tilson, Chairman of Value Investor Media, is also a principal of T2 Partners Management, LP, a registered investment adviser. T2Partners Management, LP may purchase or sell securities and financial instruments discussed in this newsletter on behalf of certain accounts it manages. It is the policy of T2 Partners Management, LP and all Related Persons to allow a full trading day to elapse after the publication of this newsletter before purchases or sales are made of any securities or financial instruments discussed herein as Investment Snapshots. Compensation Value Investor Media, Inc. receives compensation in connection with the publication of this newsletter only in the form of subscription fees charged to subscribers and reproduction or re-dissemination fees charged to subscribers or others interested in the newsletter content.
March 30, 2012
Value Investor Insight

Value Investor Insight Issue 336

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ValueInvestor

March 30, 2012

The Leading Authority on Value Investing

Inside this Issue

Ins and Outs

Other companies in this issue:

Investor Insight: Pat English

Trailing P/E Forward P/E Est.

ARW 8.1 8.4

S&P 500 16.2 13.6

Largest Institutional Owners

% Owned 9.8% 9.7% 8.1% 4.3% 4.1% 1.0%

Revenue Operating Profit Margin Net Profit Margin

THE BOTTOM LINE

March 30, 2012

Trailing P/E Forward P/E Est.

SYY 15.3 15.4

S&P 500 16.2 13.6

Largest Institutional Owners

% Owned 4.9% 3.9% 3.6% 3.4% 3.2% 3.5%

Revenue Operating Profit Margin Net Profit Margin

THE BOTTOM LINE

March 30, 2012

Revenue Operating Margin Net Profit Margin

15.60 billion 13.0% 8.0%

46.17 30.22 47.32 1.5% 21.61 billion

S&P 500 16.2

THE BOTTOM LINE

Value Investor Insight 7

Financials (FY ending 9/30/11):

Revenue Operating Margin Net Profit Margin

15.83 billion 6.4% 4.6%

6.53 4.98 6.72 3.3% 12.34 billion

S&P 500 16.2

THE BOTTOM LINE

March 30, 2012

March 30, 2012

Value Investor Insight 9

Investor Insight: Shawn Kravetz

MEMC Electronic Materials

Trailing P/E Forward P/E Est.

WFR n/a 21.7

Russell 2000 42.2 20.2

Largest Institutional Owners

% Owned 10.9% 4.7% 4.4% 2.7% 2.7% 9.4%

Revenue Operating Profit Margin Net Profit Margin

THE BOTTOM LINE

March 30, 2012

Revenue EBIT Margin Net Profit Margin

4.91 billion 12.3% 7.3%

66.06 56.87 175.50 4.8% 3.45 billion

S&P 500 16.2

THE BOTTOM LINE

Value Investor Insight 13

Trailing P/E Forward P/E Est.

SKX n/a n/a

Russell 2000 42.2 20.2

Largest Institutional Owners

% Owned 15.7% 8.0% 7.0% 6.3% 5.0% 19.5%

Revenue Operating Profit Margin Net Profit Margin

THE BOTTOM LINE

Value Investor Insight 14