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Value Investor

Value Investor

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Published by eliforu
Underwriting Value
Investors’ dislike of bad news and uncertainty can cloud their collective judgment.
When that happens, expect Jeffrey Altman to try to take advantage.
Underwriting Value
Investors’ dislike of bad news and uncertainty can cloud their collective judgment.
When that happens, expect Jeffrey Altman to try to take advantage.

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Published by: eliforu on Jul 09, 2013
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10/27/2014

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H
is training under celebrated dis-tressed investor Michael Pricewas put to an early test when Je-rey Altman launched his own hedge undin 2002. Equity markets were cratering andone-time darlings like Worldcom were goingkaput. “We put ourselves out there as hav-ing the exibility and expertise to managethrough just that type o market,” he says.Altman’s Owl Creek Asset Managementpassed that test with ying colors and – nowwith $3.1 billion in assets – continues todetly navigate volatile markets. His agshipund has earned a net annualized 13.6%since 2002, vs. 5.9% or the Russell 3000.With a long/short mandate in both eq-uity and credit, he’s fnding mispriced valuetoday in such areas as aerospace, telecom,specialty fnance and airlines.
ValueInvestor
INSIGHT
June 30, 2013
The Leading Authority on Value Investing
Underwriting Value
Investors’ dislike of bad news and uncertainty can cloud their collective judg-ment. When that happens, expect Jeffrey Altman to try to take advantage.
Inside this Issue
FEATURES
Investor Insight: Owl Creek 
Ready to pounce on market mispric-ings and fnding them today in LeapWireless, Sprint, Japan Airlines andSpirit AeroSystems.
Investor Insight: Brian Bythrow
Seeing through the market’s skepti-cism to fnd value in CPI Aero, BoIHolding, Ches’ Warehouse, CrimsonWine and Vocera.
Uncovering Value: Cedar Fair
Why this company’s stock may oera smoother and calmer ride than itscustomers typically enjoy.
PAGE 18 »
Uncovering Value: Fairfax
Ater a period as “dead money,” is ittime or a closer look at this high-profle insurer’s shares?
PAGE 19 »
Editors’ Letter
On picking up something new romyour investment toolbox.
PAGE 20 »
INVESTMENT HIGHLIGHTS
Other companies in this issue:
 Aiful, AIG, AT&T, Body Central,Boeing, Caesarstone,CommonWealth REIT,Dish Network , First Cash Financial, First Inter-net Bancorp,Forest Oil, InterLinks,Iron Mountain,Lorillard,MetLife,MusclePh- arm, National Research, Pep Boys, SixFlags, Verizon,Yahoo INVESTMENT SNAPSHOTS PAGE
BofI Holding17Cedar Fair18ChefsWarehouse13CPI Aero16Crimson Wine Group14Fairfax Financial19Japan Airlines8Leap Wireless7Spirit AeroSystems5Sprint9 Vocera Communications15
INVESTOR INSIGHT
Owl Creek Asset Management
(l to r)
Jeffrey Lee, Jeffrey Altman, DanielKrueger
Investment Focus:
Securities across thecapital structure of companies for whichthe market appears to be misinterpreting oroverreacting to prominent news or events.
*Please see the important information and additional disclosures at the end of the article.
 
 June 30, 2013www.valueinvestorinsight.comValue Investor Insight 
2
Since starting Owl Creek, you’ve been ag-nostic about investing in equity or credit,long or short. Why set it up that way?
 
 Jerey Altman:
We try to be good at un-derwriting what something is worth, otenin difcult and uncertain situations. Whenwe fnd a real discrepancy between whatwe believe something is worth and wherethe market is pricing it, we want to takeadvantage o that regardless o where thesecurity resides in the capital structure andregardless o whether we think it’s under-priced or overpriced.We gravitate toward event-driven situ-ations where there is high-profle newsthat is thought to be value disruptive. Themarket oten misprices the impact o thatnews, say by obsessing about a bad earn-ings report rom a segment o the businessthat we don’t consider that important tothe overall value case. Or by assumingthe worst in a legal or regulatory situa-tion where a deeper understanding o thedetails might indicate something less thantotal disaster. The market’s sentiment canswing too ar in either direction and we’retrying to proft rom the extremes.
Are the companies that you target typi-cally in extreme distress? JA:
It’s not all we do, but a big part, espe-cially on the credit side. There’s usually up-heaval and uncertainty about the acts indistressed situations, so security prices canbe all over the map. Also in bankruptcysituations you have investors like pensionunds and banks that are indiscriminatelydumping debt securities they can’t ownbecause they’re now non-perorming. Inthese types o cases, i you believe market-clearing prices don’t reect the underlyingrisk, that’s a real opportunity.To give a classic example, as soon asWashington Mutual blew up during thefnancial crisis we were buying up anddown its capital structure. By compar-ing the company’s fnancial statements tosome bank regulatory flings, we were ableto determine there probably was a $4.5billion deposit that the holding companyheld in its own bank subsidiary. The ques-tion was whether that $4.5 billion wouldbe an asset o the holding company, orwould have to be transerred down to thebank subsidiary, which had just been tak-en over by the FDIC. Our conclusion wasthat there was a high probability it wasan asset o the holding company, whichwould mean the senior holding-companydebt that traded at less than 10 cents onthe dollar could actually be worth par.
Daniel Krueger:
Another important ques-tion was who would be entitled to taxreunds resulting rom the bank’s losses.The intuitive answer was that the operat-ing bank generated the income and paidthe taxes when times were good, and thensuered the losses that created the tax re-unds when times were bad, so it shouldget any reunds. But the legal precedentsaid otherwise, that the IRS was obligatedunder the company’s Tax Sharing Agree-ment to pay out to the holding companyfrst, which could then treat the bank likeany other creditor in bankruptcy. I thiswere the case, that meant both the seniorand subordinated bonds should be worthpar. When this and the right to the $4.5billion were settled in our avor, our hold-ing-company debt did very well.Two points I’d make here: One, thesetypes o answers don’t just all in yourlap, they require a non-trivial level o e-ort and expertise to uncover. Also, to thequestion o where we fnd opportunity,it’s oten when there’s a binary nature tothe outcomes. We’re comortable work-ing with probabilities and making deci-sions based on expected values, but in ourexperience most investors don’t like that.They’d rather take the risk o losing a
INVESTOR INSIGHT:
 
Owl Creek 
Investor Insight: Owl Creek
Owl Creek Asset Management’s Jerey Altman, Daniel Krueger and Jerey Lee describe why they fnd opportunity inbinary-outcome situations, why there’s an Asian tilt to their non-U.S. investments, what they stopped doing ater a tough2011, and what they think the market is missing in Spirit AeroSystems, Sprint, Leap Wireless and Japan Airlines.
Jeffrey Lee, Jeffrey Altman, Daniel Krueger
On Credit
 
It’s not uncommon for the initial training oftop stock investors to have been in debtrather than equity. Case in point: JeffreyAltman founded Owl Creek Asset Man-agement in 2002 after 13 years at whatbecame Franklin Mutual Advisors, invest-ing across companies’ capital structuresin bankruptcy and other distressed situ-ations. His co-portfolio managers, DanielKrueger and Jeffrey Lee, also learned thebusiness on the credit side rst.Each is quick to point out the advantagesof such training. “One key is how deep intothe weeds you have to get in credit situa-tions in order to understand the businessand its capital structure,” says Altman. “It’ssecond-nature for us to do that on theequity side, where it’s obviously as impor-tant.” Says Krueger: “As credit investors,cash is king and there’s a hard catalyst ofwhether you get paid or not. We’re look-ing for similar situations on the equity side,where we’re focused clearly on how we’regoing to get paid and don’t worry so muchabout near-term swings in the market.”The volatile nature of distressed credit in-vesting also puts a premium on doing yourown work, says Lee, as there’s much lessconventional wisdom to tap. The transfer-able benet, he says: “It makes you morecomfortable going against the grain.”
 
 June 30, 2013www.valueinvestorinsight.comValue Investor Insight 
3
INVESTOR INSIGHT:
 
Owl Creek 
greater amount o money gradually than alesser amount potentially in one day.
How systematic vs. opportunistic is youridea generation? JA:
We do screens in the sense that i we’rein a period when the markets are doingreally well or very poorly, we’ll look atwhat’s most and least in avor or ideas.This can lead us to avor an industryrom time to time, but it depends whyit’s cheap. I it’s politically motivated andbacked by secular tailwinds, like health-care in 2010, we’re more apt to get in-volved. I it’s an industry like steel orsome other very cyclical business wherewe have a more difcult time underwrit-ing the uture, it’s not that we won’t everget involved, but the price we’re willing topay is much lower. Industries are oten ina bad place or a good reason.That said, most o our ideas comerom bottom-up work on companiesand industries sparked by any number o things, rom a headline to a conversationwith another investor about a bankruptcysituation. We also oten fnd other thingsto do by looking horizontally and verti-cally rom names already in our portolio.We’ll talk later about Sprint [S], but as anexample, our research on it also gave uswhat we believe is actionable insight intoVerizon, AT&T and Dish Network.
Why did something like Yahoo [YHOO]attract your attention? Jerey Lee:
We’ve owned Yahoo o andon or awhile, but we frst got interested init due to its stake in Alibaba Group, whichin China is kind o like Amazon and eBayput together. We’ve had an ofce in HongKong since 2008 and i you were payingattention you could see that, even thoughAlibaba was private and there wasn’tmuch fnancial inormation, it was a tre-mendously valuable asset that wasn’t wellreected in Yahoo’s share price. We’vehad a lot o these cross-border situationsin our portolio, where there’s a U.S.-listedstock and the sell side spends 80-90% o its time on the U.S. business, even thoughit may to our mind only represent 20-30%o the value o the company.
Now that part o Yahoo’s Alibaba stakehas been monetized, have you moved on? JA:
Yahoo sold roughly hal o its positionback to Alibaba last year at what we con-sidered a too-low valuation o $36 billionor the entire company. Alibaba’s valuehas continued to grow and we believe inan IPO air value is at least $100 billion. I we’re right about that, Alibaba will havear more impact to the upside on Yahoo’sshare price [now just over $25] than anytweaking o the business model in the U.S.
You sold your AIG stake recently. Wasthat because the distressed part o the sto-ry had passed? JL:
It’s one o the more crowded tradesin insurance and we concluded the turn-around in its Chartis property/casualtybusiness was going to be more difcultthan we frst expected. Given that, youwouldn’t get the same leverage on going-orward changes in pricing and interestrates that you would rom other compa-nies. There’s still potential or value cre-ation at AIG, but the value gap had closedquite a bit and rather than go ater the bal-ance, we ound better ideas elsewhere.
 JA:
While the majority o our portolio isevent ocused, sometimes we’ll fnd thingswe just think the market is missing. For in-surers, the low interest-rate environmenthas been a big drag on portolio returns.But i you look at where interest rates havebeen over the past 15 years, a 1.5% yieldon the 10-year Treasury is not even in therange o normal. So rather than hold onto AIG, we’d rather own something likeMetLie [MET], where we could pay 7xearnings or one o the best insuranceranchises out there. I interest rates nor-malize in the next three to fve years – theupside/downside on that is in our avor –we think its value could double.
Do you have a market-cap sweet spot onthe equity side? JL:
Most o our portolio is in the $2 bil-lion to $20 billion cap range. Less thanthat is difcult given the size o our undand how concentrated we are. Greaterthan that, we tend to fnd less inefciency.
You appear to have an Asian tilt to yournon-U.S. investments. Why? JL:
We have a separate Asia-ocused strat-egy, ocusing primarily on China and Ja-pan, and we have had a greater exposureto Asia than most New York-based frms.Part o that is that we’ve built our corecompetence there with investments in theregion since 2004 and having a HongKong team since 2008. But it’s also a unc-tion o opportunity and inefciency. Theequity markets there tend to be very retail-driven and short-term ocused, which ismore apt to create the types o mispricingwe try to take advantage o.
 JA:
The volatility that you’ve seen in Ja-pan over the last ew weeks is consistentwith that. That type o market can beenormously benefcial to us.
How activist are you in your positions? JA:
With distressed credit, you have to beactive because the dynamics o the situa-tion can be very uid. On the equity sidewe’re sometimes in activist situations, butwe preer to take a back seat and let some-body else drive it.One example o that today is withCommonWealth REIT [CWH], where webelieve Corvex is doing an excellent jobin working to change an external-man-agement structure at the company thatwe think is improper and severely valuedestructive. Whether investors have stand-
ON ASIA INTEREST:Part of that is we’ve investedin our core competencethere. It’s also a function ofopportunity and inefciency.

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