Tuesday, March 27, 2012

A Snapshot of Buffett's Early Years

This a wonderful account by Warren Buffett given to Forbes magazine about his decision to form his original investment partnership in 1956 (a partnership model replicated by Gad Capital Management and Gad Partners Funds), a fateful decision that ultimately led to the genesis of what Berkshire Hathaway is today.

Titled "Warren Buffett's $50 Billion Decision" the story is below. Yet visit the link for great pictures of Buffett in his early years.

Warren Buffett's $50 Billion Decision
by Warren Buffett

Benjamin Graham had been my idol ever since I read hisbook The Intelligent Investor.I had wanted to go to Columbia Business Schoolbecause he was a professor there, and after I got out of Columbia, returned to Omaha, and startedselling securities, I didn’t forget about him. Between 1951 and 1954, I made apest of myself, sending him frequent securities ideas. Then I got a letterback: “Next time you’re in New York, come and see me.”

So there I went, and he offered me a job atGraham-Newman Corp., which he ran with Jerry Newman. Everyone says that A.W.Jones started the hedge fund industry, but Graham-Newman’s sister partnership,Newman and Graham, was actually an earlier fund. I moved to White Plains, NewYork, with my wife, Susie, who was four months pregnant, and my daughter. Everymorning, I got on a train to Grand Central and went to work.

It was a short-lived position: The next year, when Iwas 25, Mr. Graham—that’s what I called him then—gave me a heads-up that he wasgoing to retire. Actually, he did more than that: He offered me the chance toreplace him, with Jerry’s son Mickey as the new senior partner and me as thenew junior partner. It was a very tiny fund—$6 million or $7 million—but it wasa famous fund.

This was a traumatic decision. Here was my chance to stepinto the shoes of my hero—I even named my first son Howard Graham Buffett.(Howard was for my father.) But I also wanted to come back to Omaha. I probablywent to work for a month thinking every morning that I would tell Mr. Graham Iwas going to leave. But it was hard to do.

The thing is, when I got out of college, I had $9,800,but by the end of 1955, I was up to $127,000. I thought, I’ll go back to Omaha,take some college classes, and read a lot—I was going to retire! I figured wecould live on $12,000 a year, and off my $127,000 asset base, I could easilymake that. I told my wife, “Compound interest guarantees I’m going to getrich.”

My wife and kids went back to Omaha just ahead of me.I got in the car, and on my way west checked out companies I was interested ininvesting in. It was due diligence. I stopped in Hazleton, Pennsylvania, tovisit the Jeddo-Highland Coal Company. I visited the Kalamazoo Stove &Furnace Company in Michigan, which was being liquidated. I went to see what thebuilding looked like, what they had for sale. I went to Delaware, Ohio, tocheck out Greif Bros. Cooperage. (Who knows anything about cooperage anymore?)Its chairman met with me. I didn’t have appointments; I would just drop in. Ifound that people always talked to me. All these people helped me.

In Omaha, I rented a house at 5202 Underwood for $175a month. I told my wife, “I’d be glad to buy a house, but that’s like acarpenter selling his toolkit.” I didn’t want to use up my capital.

I had no plans to start a partnership, or even have ajob. I had no worries as long as I could operate on my own. I certainly did notwant to sell securities to other people again. But by pure accident, sevenpeople, including a few of my relatives, said to me, “You used to sell stocks,and we want you to tell us what to do with our money.” I replied, “I’m notgoing to do that again, but I’ll form a partnership like Ben and Jerry had, andif you want to join me, you can.” My father-in-law, my college roommate, hismother, my aunt Alice, my sister, my brother-in-law, and my lawyer all signedon. I also had my hundred dollars. That was the beginning—totally accidental.

When I formed that partnership, we had dinner, theseven of them plus me—I’m 99 percent sure it was at the Omaha Club. I bought aledger for 49 cents, and they brought their checks. Before I took their money,I gave them a half sheet of paper that I had made carbons of—something I calledthe ground rules. I said, “There are two or four pages of partnership legaldocuments. Don’t worry about that. I’ll tell you what’s in it, and you won’tget any surprises.
“But these ground rules are the philosophy. If you are in tune with me, thenlet’s go. If you aren’t, I understand. I’m not going to tell you what we own oranything like that. I want to get bouquets when I deserve bouquets, and I wantto get soft fruit thrown at me when I deserve it. But I don’t want fruit thrownat me if I’m down 5 percent, and the market’s down 15 percent—I’m going tothink I deserve a bouquet for that.” We made everything clear, and they gave metheir checks.

I did no solicitation, but more checks began comingfrom people I didn’t know. Back in New York, Graham-Newman was beingliquidated. There was a college president up in Vermont, Homer Dodge, who had beeninvested with Graham, and he asked, “Ben, what should I do with my money?” Bensaid, “Well, there’s this kid who used to work for me.…” So Dodge drove out toOmaha, to this rented house I lived in. I was 25, looked about 17, and actedlike 12. He said, “What are you doing?” I said, “Here’s what I’m doing with myfamily, and I’ll do it with you.”

Although I had no idea, age 25 was a turning point. Iwas changing my life, setting up something that would turn into a fairlygood-size partnership called Berkshire Hathaway. I wasn’t scared. I was doingsomething I liked, and I’m still doing it.


Tuesday, March 20, 2012

The Special Situation Case for Rentech

Not one to usually share ideas (solely so that I can take ownership for Gad Capital's, Gad Partners Funds, and the Sham Gad Family successes and failures), here's is an idea that will appear intriguing to some while dismissed by others. It's simple in concept.

Rentech (RTK), trades at $2 a share or a market cap of $450 million. Rentech's marketable assets are worth nearly $600 million, 33% above the company's current market cap. Add in another $ million or so in net cash on the balance sheet and you have a business that aside from operations should be worth more than $800 million, or a 70% upside, if the company announced a liquidation, although there are no immediate plans to do that.

Rentech provides clean energy solutions through the production of synthetic fuels, a business is not yet commercially viable for Rentech. Management appears to "get it" and plans to reduce capital expenditures by 85% in fiscal 2012 along with a 50% reduction in R&D. Without this decision, I would have argued that the business was eroding value.

The not so hidden gem is the nitrogen fertilizer business, Rentech Nitrogen Partners (RNF) spun out last November. Rentech received around $140 million in cash from the IPO and maintained a 61% equity interest, or 23.25 units in Rentech Nitrogen.

Today, Rentech Nitrogen trades for a market valuation of $990 million, which places Rentech's 61% stake at a value of around $600 million. As an MLP, Rentech Nitrogen plans to distribute out all its available cash flows which according to company guidance, will be $2.34 a unit in 2012. Given the slowdown in the fertilizer industry, it's possible that this initial distribution will come in lower than expected although I should note that nitrogen fertilizer prices continue to hold up along with the fact that RNF has a majority of its production hedged at prices that would support the implied distribution.

In short, Rentech owns 61% of a very attractive cash-generating business and will collect a nice dividend with each payout (over $50 million at the implied distribution). Rentech's balance sheet consists of $240 million in cash (around $40 million at Nitrogen) and $50 million in debt, or a net cash position of about $190 million. Add in the current market value of Rentech Nitrogen stake, $600 million, and you get a value of $790 million.

I assume that the energy business is value destroying; however, one should note that the energy segment sits on $90 million in federal net operating loss carry-forwards which can be used to offset taxable income, including any distributions from income from Rentech Nitrogen. Rentech is a cash- and asset-rich investment play that should be conservatively worth between $600 million and $750 million, or $2.70 to $3.50 a share.

There you have it, enough information to wet your whistle. There's more to the story, but better to teach a man to fish than give him one.

Disclosure: Long RTK

Monday, March 12, 2012

Berkshire Hathaway Analysis: Still Relevant Today

by Sham Gad

It's widely known that very few analysts attempt to follow or analyze Berkshire Hathaway. That's perfectly alright with Warren Buffett. Here at Gad Capital and the Gad Partners Funds, it is more than satisfactory to rely on the company's annual reports and Buffett's annual letter. Rarely does a CEO devote dozens on pages each year educating his shareholders are about how to value a business, including Berkshire Hathaway.

But one analyst report back in 1999 earned Buffett's stamp of approval. It was written by none other than Alice Schroeder, whom Buffett picked several years ago to pen his biography. Despite being penned in 1999, the analysis is as relevant as ever because the report does a magnificent job of educating the reader on how value Berkshire from four perspectives. Those perspectives are the same ones Buffett applies today and always.

The report in its entirety can be read by clicking here. It's a must read for anyone interested in investing.

Wednesday, February 22, 2012

One of the Greatest Ever

A true loss for the value investing community took place last week when legendary investor Walter Schloss passed away. Without greats like Walter Schloss, there would be no Gad Capital Management, Sham Gad Partners Funds, or anything else I have done related to investing.

About four years ago I had the distinct pleasure of hearing Schloss speak in New York. This was a gem of an experience - I think I was one of maybe 10 people getting to hear the living legend speak on value investing, Ben Graham, Warren Buffett, and many other great stories. My biggest takeaway: schloss's deep disregard for debt. He kept making the comment and I quote "I just don't like debt. There is too much trouble in having debt". Little did I know that Walter's cooments were a timeless lessons that would come to manifest themselves several months later.

I count myself among the lucky few who were able to meet and speak with Mr. Schloss.

Here's a great piece on Schloss from Bloomberg: (I've abridged this...click to go to full article)

From 1955 to 2002, by Schloss’s estimate, his investments returned 16 percent annually on average after fees, compared with 10 percent for the Standard & Poor’s 500 Index. (SPX) His firm, Walter J. Schloss Associates, became a partnership, Walter & Edwin Schloss Associates, when his son joined him in 1973. Schloss retired in 2002.

Buffett, a Graham disciple whose stewardship of Berkshire Hathaway Inc. has made him one of the world’s richest men and most emulated investors, called Schloss a “superinvestor” in a 1984 speech at Columbia Business School. He again saluted Schloss as “one of the good guys of Wall Street” in his 2006 letter to Berkshire Hathaway shareholders.

“Walter Schloss was a very close friend for 61 years,” Buffett said yesterday in a statement. “He had an extraordinary investment record, but even more important, he set an example for integrity in investment management. Walter never made a dime off of his investors unless they themselves made significant money. He charged no fixed fee at all and merely shared in their profits. His fiduciary sense was every bit the equal of his investment skills.”

Began as ‘Runner’
To Buffett, Schloss’s record disproved the theory of an efficient market -- one that, at any given moment, assigns a reasonably accurate price to a stock. If companies weren’t routinely overvalued and undervalued, Buffett reasoned, long- term results like Schloss’s couldn’t be achieved, except through inside information. Schloss, who never attended college, began working on Wall Street in 1935 as a securities-delivery “runner” at Carl M. Loeb & Co.

The Schloss theory of investing, passed from father to son, involved minimal contact with analysts and company management and maximum scrutiny of financial statements, with particular attention to footnotes.

Focus on Statements

“The Schlosses would rather trust their own analysis and their longstanding commitment to buying cheap stocks,” Bruce Greenwald, Judd Kahn, Paul Sonkin and Michael van Biema wrote in “Value Investing: From Graham to Buffett and Beyond,” their 2001 book. “This approach,” the authors wrote, “leads them to focus almost exclusively on the published financial statements that public firms must produce each quarter. They start by looking at the balance sheet. Can they buy the company for less than the value of the assets, net of all debt? If so, the stock is a candidate for purchase.”

An example was copper company Asarco Inc. The Schlosses bought shares in 1999 as the stock bottomed out around $13. In November of that year, Grupo Mexico SA (GMEXICOB) bought Asarco for $2.25 billion in cash and assumed debt, paying almost $30 a share.

‘Guts to Buy’

“Basically we like to buy stocks which we feel are undervalued, and then we have to have the guts to buy more when they go down,” Schloss said at a 1998 conference sponsored by Grant’s Interest Rate Observer. “And that’s really the history of Ben Graham.” Buffett, in his 2006 letter to shareholders, said Schloss took “no real risk, defined as permanent loss of capital” and invested “in about 1,000 securities, mostly of a lackluster type. A few big winners did not account for his success.”

Edwin Schloss, now retired, said yesterday in an interview that his father’s investing philosophy and longevity were probably related. “A lot of money managers today worry about quarterly comparisons in earnings,” he said. “They’re up biting their fingernails until 5 in the morning. My dad never worried about quarterly comparisons. He slept well.”

Early Lessons

Schloss first met Buffett at an annual meeting of wholesaler Marshall Wells, which drew both investors because it was trading at a discount to net working capital, according to a 2008 article in Forbes magazine. When Buffett joined Graham- Newman, he and Schloss shared an office. While Buffett became a star inside the firm, Schloss was “pigeonholed as a journeyman employee who would never rise to partnership,” Schroeder, a Bloomberg News columnist, wrote in her book.

Wednesday, February 8, 2012

How to Beat the Market? Avoid It.

If I challenged you to take on Tiger Woods, how would you beat him? You may think I’m asking an idiotic question, but in actuality there is some great value to be learned here. The fact is Tiger is beatable and I know how to beat him: by not playing him in golf.

As long as you take on the world’s best golfer in anything but golf, odds are you stand a good chance of winning. Think about this idea for a moment with respect to the stock market and investing. Your best chance of beating the market is by avoiding it. Let me explain.

Today’s market environment is dominated by institutional money collectively managing trillions of dollars. These large funds demand equity research, analyst estimates, and other investment decision related needs. These services are gladly provided by the hundreds of equity research firms and investment banks who exist solely to cater to these needs.

Because these investment funds are dealing with large pools of capital, they are looking for places to allocate tens of millions if not hundreds of millions of dollars in a relatively short amount of time. As a result, the vast majority of investment capital is playing in the same sandbox. And that sandbox is filled with larger cap companies that most are familiar with. There is nothing wrong with this approach; in fact by default it’s the only approach to follow if you are part of a large pool of investment capital.

Luckily for the individual investor or smaller account (sub $200 - $300 million), you don’t have to play in this sandbox. In fact, in most cases you should try to avoid it because chances are that you will have no edge over the other players. In other words, there is a higher degree of efficiency when you have more participants.

Of course when an opportunity like the financial crisis of 2008 leads to a market wide sell off and everything is on sale, that’s a different story. When you can buy a company like Apple for $90 in the midst of a market panic as you could have two years ago, you pull the trigger quickly. Or when Whole Foods (WFMI) was trading for under $10 a share in late 2008 after having earned $1.30 in 2007, you didn’t need to think hard about the value proposition. But those opportunities don’t come along so often.

Today, financials offer the same home-run type opportunities but will likely take a little longer to play out. I would argue that Bank of America (BAC) for those investors with a 2-3 horizon will profit handsomely at today's current valuation. 

There is ample opportunity, however, where the big boys can't look. A $10 billion investmetn fund is not going to be spending a lot of time looking at companies with market caps below $500 million. And as a result, most analysts who service them aren't looking there either.

Don’t make investing harder than it already is. Leave the big boys to fight over the big fish while you focus on the easy pickings of the smaller and potentially more lucrative opportunities. Happy hunting!

Wednesday, February 1, 2012

Investing in Quality Always Takes the Cake

Warren Buffett has spent the past 60 years amassing an untouchable investment record. His endurance through recessions, market bubbles, and financial panics is what truly sets him apart in the game. Buffett is indeed a value investor. When I apply the term value investor to Buffett, the definition I give is the response Buffett gives: what other type of investing is there if it isn't the act of seeking value? 

The concept of value investing as the only type of investing is a profound statement and one I hang my hat on here at Gad Capital Management. For the first 15 years or so in his life, Buffett made his money buying cheap, low quality cigar butts that pocketed him 20% - 30% gains in a relatively short period of time. That beginning gave Buffett his name. What made his career was a entirely different approach that he has honed in on for nearly 50 years: buying quality businesses at slightly undervalued or fairly valued prices. 

To most value investors, buying a fairly valued security seems contradictory to the value investing approach. On the contrary, I would opine that what gets many "value investors" in trouble is sticking to statistically cheap stocks and ignoring the value in quality stocks trading at reasonable valuations.

The ultimate key to value is, of course, price. But if you buy a statistically cheap stock without any value creating catalyst, you many find yourself waiting a very long-time for that value to be unlocked. On the other hand if you are able to buy a quality issue at a reasonable price, you may come to find a lot of value creation over the years that such an investment is held.

Indeed, one of the best types of a margin of safety is quality. Indeed, the man himself speaks exactly to that point. In Chapter 20 of The Intelligent Investors, Ben Graham suggests:

However, the risk of paying too high a price for good-quality stocks - while a real one - is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions....These securities do not offer an adequate margin of safety in any admissible sense of the term. (emphasis added)

Indeed if you buy an excellent business trading at 90% of intrinsic value but that company can grow its future cash flows, then isn't intrinsic value going to increase over time, thus giving you a wider margin of safety? Isn't this the case with Apple (NASDAQ: AAPL), which out of great irony, has never traded at a nosebleed valuation over the past several years despite producing the type of growth rates that any tech company would dream for? In the company's most recent quarter, it generated $13 billion in net profit, almost the amount of income generated in all of fiscal 2010. Isn't a company with that growth potential and high quality trading at 20 times earnings a better value proposition than a single digit P/E, low book value stock that may suffer losses at the first sign of economic trouble?

I've learned this lesson the hard way with my personal example, Chipotle Mexican Grill (NYSE: CMG). If it's lunch or dinner time and there is a Chipotle with 15 miles, that is where I am going. And apparently so are hundreds of other people all throughout the day. Chipotle, by all measures, is a fantastic business in an industry that is not all that fantastic. Chipotle takes fine dining type food and sells it quickly and at a very attractive price. I have been the biggest advocate for this company to anyone I talk to. (Steve Els, if you happen to read this, I just want you to know that Sham Gad has probably turned on over 100 people to Chipotle who probably eat there twice a week.)

Yet what was glaringly obvious to me from a business perspective was not so obvious from an investment perspective because I anchored too much on numerical quality and not enough on qualitative attributes. So when the Great Recession gave me a chance to buy Chipotle at $130, or 20 times earnings, I stalled. Fast forward three years later and what Chipotle is earning now equates to about 12 times earnings that share price. (As a consolation, my hometown is getting its first Chipotle in 2012, which I hope will serve as a constant reminder of my error of commission.)

It is precisely this approach to investing that led Buffett to See's Candies, Coca-Cola, The Burlington Northern, and most recently, to committing $10 billion to IBM. When Buffett bought The Burlington Northern, esteemed value investors took him to task as paying too much for a capital intensive business. Now the consensus is that he bought the railroad for half of what it would sell for today.

Making investments casts a wide net. Special situation opportunities like my recent discussion on Premier Exhibitions (PRXI) doesn't fit the mold of quality per se, but it does pass the test of probability. After all, investing is nothing more than a probabilistic exercise. What quality does is skew the probability of a favorable outcome squarely on the side of the value oriented investor.

Saturday, January 28, 2012

Premier Exhibitions Finally Get It's Big Payoff in 2012

by Sham Gad

I'm usually not one to discuss positions in businesses we own until after I have exited them, but since I have readily discussed Premier Exhibitions (Nasdaq: PRXI) to the investors of Gad Partners Fund in numerous letters to partners, this information won't be new to any of them (or many others who have followed PRXI  for that matter.) Besides, if all goes well, the thesis will play out in a manner of months. Even still, there is a high probability that shares remain significantly undervalued.

NOTE: The Gad Partners Fund as well as personal accounts of Sham Gad have established positions in this security at prices, that in most cases, are significantly below today's market price.


PRXI: Not Too Late to Cash In

Premier is a provider of high-quality museum-type exhibitions. The company's two best-known exhibits are BODIES and TheTitanic. The value-creating catalyst resides in the Titanic assets. Premier's subsidiary owns approximately 6,000 Titanic artifacts, acquired through years of diving and exploration. It is those assets that provide the current catalyst that will drive the company's valuation higher in the very near future.

In December 2011, Premier announced its intent to auction off its Titanic assets in April 2012, the 100th anniversary of the ships sinking. For more than 10 years, Premier has been involved in litigation regarding the title to those artifacts. Last August, a court finally awarded Premier the remaining set of artifacts it did not own. During that legal process, professional appraisers valued those artifacts in excess of $110 million. Those artifacts, along with the others in Premier's possession, are collectively worth $190 million.

Premier is debt free and has a market cap approaching $100 million. News of the Titanic auction did not move shares much -- a signal that the market believes that the auction will not even fetch appraised value for the assets. I believe the market has it wrong; in fact, it's likely that the auction will result in a sale price in excess of the appraised value.

Consider the following:

  • In October 2011, Phillip Weiss Auctions offered artifacts from a couple who were honeymooning on the Titanic. Those artifacts were estimated to fetch between $30,000 and $50,000. Those artifacts sold for $100,570.   
  • That same month, England's Henry Aldridge & Son auctioned several Titanic artifacts, including a deck plan of First Class Accommodations used by a survivor. It was estimated that the deck plan would fetch between $50,000 and $80,000. The final sale price was more than $150,000.
Premier, in all likelihood, is going to reside over one of the most highly publicized and significant auctions in decades. At the appraised price of $189 million, shares are worth $4 before you include the company's intellectual property or exhibition business. That's 120% upside in four months. If the auction goes better than expected, then you can see how incredible the upside is.

I have spoken with management on numerous occasions. They get the tax issue and are squarely focused on managing any taxable transaction in order to maximize shareholder value.

Is there a chance that the auction doesn't succeed? Sure, there is always an element of uncertainty involved in any investment thesis. But if you look at PRXI's track record since Mark Sellers took control, they have accomplished everything they set out to do with respect to the Titanic assets. I for one, ascribe little value to the exhibition business for purposes of the valuation, but keep in mind that the exhibition business could be of enormous utility to anyone who owns the artifacts.

Successful investing requires building mental models and using those models to construct a story. In the case of Premier, one has think of who might be interested in owning not merely assets of a sunken ship, but arguably the most historic maritime tragedy in the world. A 15 year court saga is merely but one clue as to how significant these assets are deemed. At one point, Jerry Jones, owner of the Dallas Cowboys, was interested in having the massive Titanic hull at the new Cowboy stadium. In terms of historical significance and public curiosity, Titanic is right up there with King Tut, the most successful exhibit of all time. Use your imagination as to who want to own such a collection. My initial thought is that some affiliation with a museum or philanthropic organization is what will happen. I like to get really creative and think that a Steve Wynn type buyer could really be interested and bring this collection to his casinos.

By definition, an auction of any kind is a bet on an uncertain outcome. Auctions can and do flop. Investing is ultimately a probabilistic bet. I deem a worst a case scenario being the assets get sold at appraised value with a tax hit: in that case shares are probably worth 10% to 20% above the current price. Given management's keen focus on structuring any sale in the most advantageous manner suggest that even a worst Case outcome will be better than my assumptions.

An interesting point to keep in mind: because shares trade below $5, many mutual finds are prevented from owning shares. A reverse split could change that dynamic very quickly.

Disclosure: Both Gad Partners Fund and Sham Gad hold a long position in PRXI.

Thursday, January 26, 2012

What Investors Really Need to Know About Shareholder Activism

Corporate attorney Derek Bork at Thompson Hine recently released a gem of an article on shareholder activism. The article is a fascinating insight into one of the most intriguing aspects of investing today. Shareholder activism is not only the Carl Icahn type procedure you see today. Buffett in his early days was a huge activist in many of the investments he made for the Buffett Partnerships.

Most importantly, Mr. Bork's article is a refreshing illustration that successful activism is not only an arena for the large institutional investor or hedge fund, but for the smaller investor as well. With having a clear strategy and plan in mind, activism can clearly back fire, costing investors valuable time and money. Small or big, anyone interested in activism would be well advised to consider the blue print laid out by Mr. Bork.

"One of the biggest mistakes that some activist investors make is engaging in activist tactics without a clear strategy. It is easy to see the tactics that other activists use in the marketplace, but it is not always clear on the surface why they are using them. The tactics that an investor should use may vary widely from one situation to another, depending on the circumstances of the company, its legal defenses, the size of the investor’s position, the make-up of the shareholder base and other factors."

Read the article here.