ValueInvestor

May 27, 2011

The Leading Authority on Value Investing

INSIGHT
F E AT U R E S

Impeccable Logic
They and the companies they invest in may not be particularly well known, but Dennis Delafield and Vince Sellecchia have built a record worthy of wide acclaim.

Inside this Issue
Investor Insight: Delafield Fund Roving off the beaten path to find value in such companies as Collective Brands, Albany International, Ferro PAGE 1 » and Checkpoint Systems. Investor Insight: Lloyd Khaner Looking for signs of unexpected recovery and finding them today in Sonic Corp., Cadence Design, OchZiff and Illinois Tool Works. PAGE 1 » Strategy: Real Estate In a sector where recovery has been fitful at best, two experts assess today’s opportunity set. PAGE 16 »

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ennis Delafield's first job in 1957 was at a small investment firm in Florida, but it wasn't exactly the culmination of a life-long ambition. “They offered me a job and I needed one,” he says. “I didn't know a stock from a bond.” The career match couldn't have been better. Still going strong at 75, Delafield and partner Vincent Sellecchia now manage $2.2 billion for Tocqueville Asset Management, the bulk of which is in the Delafield Fund, which has earned a net annualized 11.6% over the past 15 years, vs. 6.5% for the S&P 500. Trafficking in “misunderstood and unloved” companies, they are finding opportunity today in such areas as shoes, anti-theft systems, industrial equipment See page 2 and chemicals.

INVESTOR INSIGHT

Dennis Delafield, Vincent Sellecchia Delafield Fund Investment Focus: Seek companies undergoing positive change whose share prices indicate the market is skeptical, or unaware, of their future prospects.

Uncovering Value: Skechers Is the market right in treating the trend-conscious shoe company as if PAGE 21 » it’s a one-hit wonder? Editors' Letter Advice for those trying to win at the Loser’s Game of investing. PAGE 22 »
INVESTMENT HIGHLIGHTS INVESTMENT SNAPSHOTS
Albany International Cadence Design Systems

Comeback Trails
Long-term investors spend considerable time trying to separate fact from fiction in corporate plans. For Lloyd Khaner, that’s proven to be time very well spent.
INVESTOR INSIGHT

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Lloyd Khaner Khaner Capital Investment Focus: Seeks companies requiring operational and strategic repair – after the turnaround has commenced but before the market appears to believe it.

e followed in his father's footsteps in the investment business, but Lloyd Khaner didn't go down exactly the same path. “My Dad was very much a cigar-butt, 50-cent-dollar kind of investor and very good at it,” he says. “That's not what I do.” Khaner has proven very good at what he does as well, focusing on high-quality companies that have lost their way and have first-class management leading the turnaround. Since he took full control of Khaner Capital's portfolio in 1997, it has earned a net annualized 11.1%, vs. 6.2% for the S&P 500. With companies in need of revival always in ready supply, he sees particular value today in fast food, software, asset manageSee page 9 ment and industrial products.
www.valueinvestorinsight.com

Checkpoint Systems Collective Brands Ferro Forest City Enterprises Henderson Land Illinois Tool Works Och-Ziff Capital Management Skechers Sonic Corp.

Other companies in this issue:
Campbell Soup, Celanese, Kennametal, Lennar, Plexus, School Specialty, Sears Holdings, Stanley Black & Decker, Starbucks, St. Joe, Tyco International, Weatherford, Xerox

I N V E S T O R I N S I G H T : Delafield Fund

Investor Insight: Delafield Fund
Dennis Delafield and Vincent Sellecchia of the Delafield Fund describe why their portfolio companies are hardly a glamorous lot, a key impetus to the “special situations” they typically pursue, why cash is more valuable than ever, and why they see mispriced value in Collective Brands, Albany International, Checkpoint Systems and Ferro.
You often remind your investors of your strategy in what strikes us as a refreshingly clear and succinct way. Can you repeat that for us here? Dennis Delafield: We’ve been at this for a long time, so we should be able to describe what we think is a logical approach to protecting our investors’ capital and making it grow. We search widely for stocks that are selling at prices which seem to be modest in relation to the underlying company’s intrinsic value. We meet with management, visit plants, talk to competitors and do all the groundwork necessary to understand the business and the people who direct the company’s future. We search for companies in which change can alter that future for the better. That can mean a change in management. It can mean a change in management’s attitude toward running the business, say by recognizing that 120% of the earnings come from 80% of the assets, so they should do something about that other 20% at some point. It can mean a new business opportunity that has yet to take off. It can mean a change in the dynamics of a company’s cash flow and how it’s to be used. If we perform our analysis correctly, the value added we bring is an earlier and better understanding of the companies in our portfolio than other investors might have. If the companies then begin to improve, their earnings should increase and they’re likely to earn a higher price/earnings multiple. Finally, we believe stock selection is much more relevant to successful investing than a total commitment to equities. As markets have gotten more volatile over the last 15 to 20 years, we’ve come to believe that the best hedge against volatility is to have cash on hand with
May 27, 2011

which to invest when stock prices seem unduly depressed. Your portfolio companies today are a pretty unglamorous and low-profile lot. Is that typical? DD: Our sweet spot tends to be in small and mid-size companies that often aren’t particularly well followed by Wall Street. It would be illogical for us to know or uncover something about Procter & Gamble or Texas Instruments before 100 smart analysts did. Vincent Sellecchia: Often businesses with high profiles or in sexy industries are the hardest to understand. They might be in a wide variety of disparate businesses. They might be in technology industries with very short product life cycles. It’s easier for us to get our arms around the basic industrial company in the heartland. We also tend to find more special situations in industries with higher cyclicality, which most often aren’t the most glamorous sectors of the economy. How companies both prepare for and respond to industry capacity utilization rates going from 100% to 30% and earnings falling off a cliff has a dramatic impact on their future prospects. If the down cycle makes entry points attractive, that can create excellent opportunities. Kennametal [KMT] is a classic example of the type of situation we find interesting. After a change in CEO, the company, which makes metal-cutting tools, went through an extensive restructuring of its business portfolio and manufacturing footprint to focus on its core competencies and on businesses generating free cash flow, while also paying down debt. All of that was poised to pay off when the economic crisis took revenues down 45%. We had an existing position and added to it, given the operating leverage
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Dennis Delafield, Vincent Sellecchia

Go With the Flow
When Dennis Delafield took his first investing job after graduating from Princeton in 1957, Dwight Eisenhower was president, the Dow Jones Industrial Average was around 500, and the average turnover on the New York Stock Exchange was less than one million shares a day. What’s remained relatively unchanged over that time, he says, is the basic analysis required to understand companies and their businesses. The biggest change: volatility, both in trading and in the economic system overall: “With all slack squeezed out of the system and individuals and governments levered to the hilt, for investors there’s much more of a premium now on being nimble, on being flexible, and on having plenty of reserves on hand when volatility hits.” Delafield today shares portfolio management responsibilities with Vincent Sellecchia, who joined what was then an independent Delafield Asset Management in 1980. (The firm is now part of Tocqueville Asset Management.) Both remain hands-on analysts, which they would have no other way. “Look, the business is fun because you learn something new every day,” Delafield says. “I can’t imagine giving that up.”
Value Investor Insight 2

but our time horizon on any given holding is purely a function of what’s going on with the business and how the market is valuing it at any given moment. where just one of the giant plants they are planning to build in China could Can you give a recent example? DD: We bought shares last quarter in Plexus Corp. Is that a good thing for disciplined value investors? DD: Markets have always responded to fundamental surprises. corn crop is used to make fuel ethanol. Celanese [CE]. We haven’t yet heard any mention of business quality as a criterion. isn’t paramount to our decision to buy. with Stanley Black & Decker [SWK] stock having moved higher yet since the deal [to a recent $73. volatility can clearly create buying opportunities when we believe the reasons for the miss are temporary. that may have to change. Coke continues to push the new systems and we think the delays are just short-term noise obscuring an overall long-term financial model for the business that remains intact – with 15% annual revenue growth. In either case. [PLXS]. where we think there’s something going on which the market hasn’t recognized that can make it better than average. www. it was more focused on what the company had done to make itself much more profitable. If it does. Celanese would be well positioned to benefit. Can you generalize about the time horizon for most of your investments? VS: We tend to do our work looking out two to three years. eventually add $1 per share in earnings power. decent-sized companies that just don’t get the attention from Wall Street that they once did. in a company’s business. enjoys a substantial technology-driven cost advantage in its largest business. DD: One thing I’d add is that as brokerage firms have gone out of business or cut back on the number of companies they follow. we increased our holdings because the deal made a good strategy fit with large cost synergies. the shares trade at less than 9x earnings and around 5.com . so there are company-specific reasons we own each one of those positions. We’re perfectly happy looking for the average company.S. Our thesis went beyond just the cycle turning up again. and despite the fact that the share price was substantially higher than when we initially set up our position. and as the content of its products per automobile expands. On 2013 estimates. the stock [recently trading at $37.S. you have to be very careful about the valuation you assign to the earnings and cash flow stream. for example. not structural. Given that we expect earnings power to be in excess of $3 per share in the next few years. day traders and short-term oriented hedge funds reacting to whatever it is exactly that they react to.50]. When that edge isn’t clear. a mid-tier electronics manufacturing services company with annual revenues of about $2 billion. in and of itself. we see significant potential in the company’s coal-to-ethanol technology.valueinvestorinsight. We do make every effort to understand what edge the company has in facing competitive threats or maintaining pricing power. VS: We would love to own great businesses as much as the next guy. it’s still not at all expensive. Is there ever a thematic element to your cyclical bets? DD: Everything we do is from the bottom up. For example. Today. typically positive structural changes in the company or its markets that we believe are underway and that the market isn’t pricing in. Longer-term. As more and more of the U.20] still appears to us as a compelling value. 5% operating margins and a high-teens return on invested capital. recovers. we initially purchased Stanley Works several years ago and management has done a good job in managing the portfolio of businesses. You can find plenty of established. but it is a sound holding especially if the company can come close to its 2015 goals of 15% operating margins on $15 billion in revenues.I N V E S T O R I N S I G H T : Delafield Fund we expected from the company as volumes eventually picked up. it’s not as if we need to focus on tiny or new companies to find those that are relatively ignored. More than a year ago they acquired Black & Decker in a stock deal. Even with all that. But business quality.5x EBITDA on an enterprise value basis. What’s relatively new is the volatility driven by the high-frequency traders. Right now in the U. The shares fell sharply after management lowered revenue and earnings expectations for the second half of its fiscal year. You mentioned markets becoming more volatile over the years. 10% gross margins. While they haven’t deployed as rapidly as expected. auto manufacturing. you can only make industrial ethanol. You recently had nearly 25% of your assets in chemical companies. it isn't what I'd consider cheap. but the problem is finding them at the right price. Value Investor Insight 3 ON BUSINESS QUALITY: You’re rewarded as much for an average company getting better as you are for a good company becoming very good. while the stock has come up somewhat since we bought it. acetyl intermediates. positive and negative. not fuel ethanol. from coal. due largely to shortfalls in deliveries of complex new beverage dispensing machines the company is building for Coca-Cola. Its advanced engineered materials business is also poised for substantial growth as its primary end-market. 2011 late into meaningful margin improvement as industry utilization improves and incrementally higher-cost production comes on line. which should transMay 27. You’re rewarded as much for that as for a good company becoming very good. That translates to about $10 per share of earnings power.

5x forward EBITDA – has only gotten better. Each has gone through a top-to-bottom overhaul after being undermanaged by previ- Collective Brands (NYSE: PSS) Valuation Metrics (@5/26/11): Business: Footwear retailer through Payless Shoe Source and Stride Rite stores and wholesaler through brands such as Keds. which provides basic educational supplies to public schools. which is crimping demand and making it very difficult to pass through materials-cost increases. As the stock hit post-crisis highs last quarter. We often find ourselves selling to more growth-oriented investors. Management was doing the right things to improve the company’s operating profitability. Sources: Company reports. but we sold the stock after concluding cuts in state and local education budgets were likely to be too much of a demand headwind for the foreseeable future. but have become increasingly concerned about its exposure in the Middle East and about what we consider to be a fairly levered balance sheet.4% 2. Inc.4 billion in annual sales. Turning to some of your favorite current ideas. we took money off the table. We’ve invested successfully in oilfield-services company Weatherford International [WFT]. however. then called Payless ShoeSource.7 10. Sperry and Top Sider. DD: Our view on a position can also change as the situation warrants. Tyco International [TYC] has been a good investment for us and we think the company has excellent growth prospects.3% 5. for example. as did unusually cold and wet weather during the first quarter. The Stride Rite retail operation in the U. After a very recent hit to the share price. says Vince Sellecchia. Share Information (@5/26/11): Trailing P/E Forward P/E Est. but as the stock price has reflected that. The real gem. consisting primarily of the Saucony.8% 4. he believes the risk/return equation for the company’s stock – trading at 4. Its target customers are still hurting economically. earns double-digit operating margins and continues to grow nicely. however. we’ve reduced our position. but we’ll admit that determining that is as much art as science. has been refurbished and should breakeven this year as it continues to turn around after years of losses. There are no hard and fast rules. other publicly available information www. The anchor on performance is the domestic retail business. which caused the stock to sell off more than 15%. Higher fuel costs have also impacted customer spending.5 million $3. The international retail business generates $500 million in annual revenue. VS: We got interested in the company. 2011 shoe retailer to a more-diversified and international retailer and wholesaler. describe the investment case for recently in-the-news shoe company Collective Brands [PSS]. All this was clear in the recently reported results.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 15.valueinvestorinsight..9% 4. (@3/31/11): PSS 8.8% Company Primecap Mgmt Blum Capital Wells Fargo Vanguard Group State Street Short Interest (as of 5/13/11): % Owned 10. which serves the economy-minded consumer and accounts for nearly 60% of the company’s $3.6% 30 25 20 15 10 5 0 Revenue Operating Profit Margin Net Profit Margin PSS PRICE HISTORY 30 25 20 15 10 5 0 2009 Shares Short/Float 2010 2011 THE BOTTOM LINE Woes in the company’s domestic retail operations are obscuring important and building successes in its international and wholesale businesses.4 S&P 500 16. is in the rest of the business.96 0. INVESTMENT SNAPSHOT Where we see value being created. Saucony. is the $700 million wholesale business.9% 4.6 13.S. when Matthew Rubel came in as CEO after a very successful stint running Nike’s Cole Haan dress-shoe division.com Value Investor Insight 4 . which sells children’s shoes. VS: Another example where we’ve responded to a changed situation is in School Specialty.6% 17.27 12. Keds and Sperry brands that were part of Stride Rite. [SCHS]. he’s been transforming the company from what was a mostly domestic discount May 27.I N V E S T O R I N S I G H T : Delafield Fund How rigid is your selling discipline? VS: We’ve always said we want to sell stocks when they’re fairly valued. but in general we should be cutting back and moving on if the valuation appears to reflect whatever information we considered our edge at the outset.41 – 23.37 billion 4.0% $939. Starting with the 2007 acquisition of Stride Rite.

For Sperry. (@3/31/11): AIN 17. but we have confidence in management's ability to deal with the near-term issues and believe the risk/return from today’s price is quite attractive.com Value Investor Insight 5 . with a 30% share.50 15. up from 6% in 2010. it means capitalizing on the brand’s heritage in a similar way to what Nike has done with Converse.3 million 11.2 billion is only 4. Is there anything to be done with the Payless retail business in the U. That should eventually happen and when it does. Last year the wholesale business grew 22% and we believe it can be a $1 billion business over time. May 27. down from $1. we think the more modest near-term outlook is fully reflected in the share price. and should reach the mid-teens as revenues expand. say.5x estimated EBITDA for the coming fiscal year.9% $827.7 million $952. 2011 this may not be for the faint of heart. generating two-thirds of its nearly $1 billion in annual sales.I N V E S T O R I N S I G H T : Delafield Fund ous management. engineered fabrics.9% 8.0 12. he believes it ignores significant upside from a potential breakout business selling composites to aerospace manufacturers. The current enterprise value of $1.5% 5. so there’s always a question whether there’s space in the market for Payless to sell.1% 5. With the stock trading at a recent $15.8x estimated EV/EBITDA multiple on the stock fairly values the company’s unexciting but profitable core businesses – primarily selling “machine clothing” to the paper industry – says Vince Sellecchia. which is private.1% 4.6 S&P 500 16.1% Company Wellington Mgmt Columbia Wanger Asset Mgmt Tocqueville Asset Mgmt Vanguard Group Times Square Capital Short Interest (as of 5/13/11): % Owned 7. which should have a positive impact on earnings and cash flow.73 in fiscal 2010.10 per share. Over time the business mix should improve as the wholesale business grows at a faster rate than Payless.S. while its next closest competitors such as Xerium. While earnings have fallen more than we previously expected. The big competitors are discount stores like Wal-Mart and Kohl’s. we’d expect the building strength of the other businesses to get more attention. engineered composites and insulation materials.8% 5. This includes the fabric and belts that move pulp through the paper-manufacturing process. Describe the potential you see in one of your low-profile industrials. we’re now expecting earnings for the 2011 fiscal year ending in January to come in around $1. there’s a small composites business – with less than $50 million in revenues – selling primarily carbon-reinforced products to aerospace manufacturers. Share Information (@5/26/11): Trailing P/E Forward P/E Est. other publicly available information www. For Keds. Albany is INVESTMENT SNAPSHOT the largest supplier to this global market. it means reaffirming a commitment to product innovation. but this business won’t truly get back to normal until its economically challenged target consumer comes back.6 13. and AstenJohnson. I’ll come back to that later. Albany International [AIN]. Finally. Most of the rest of the business is in making specialized doors used in industrial plants and in selling other products – like filters and winter-coat insulation – made using similar weaving technology to that used to make paper-machine clothing. which is publicly traded. $35 shoes rather than $20 ones. Given the earnings turmoil. We expect its operating margins to increase to 10% this year.? VS: Positioning has always been an issue.00 – 28. Albany International (NYSE: AIN) Valuation Metrics (@5/26/11): Business: Diversified manufacturer of paper-machine clothing. is selling paper-machine clothing [PMC]. are no more than half as big. industrial door systems. how are you looking at valuation? VS: Given the latest weakness in the Payless domestic business. Sources: Company reports. that has meant expanding the line beyond traditional boat shoes.0% 40 35 30 25 20 15 10 Revenue Operating Profit Margin Net Profit Margin AIN PRICE HISTORY 40 35 30 25 20 15 10 5 2009 Shares Short/Float 2010 2011 5 THE BOTTOM LINE While the current 5. They’re putting some effort into that and doing things like expanding the offerings of higher-margin accessories. For Saucony.1% 5.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 26.08 1.25. VS: The company’s main business.valueinvestorinsight.

com Value Investor Insight 6 . The bulk of the spending on that capacity shift has been made. How inexpensive do you consider the shares. Can we assume the composites business you mentioned provides some sizzle? VS: That’s the interesting part of the story. the multiple on our 2012 EBITDA estimate of $190 million is about 5.valueinvestorinsight. What do you think the market is missing in Checkpoint Systems [CKP]? DD: Checkpoint has two primary businesses.S.30 per share. 2011 lion.” Sources: Company reports. This has been a priority of CEO Rob van der Merwe’s since he joined the company from Paxar. a very successful label business he sold to Avery Dennison.3% 30 25 20 15 10 5 Revenue Operating Profit Margin Net Profit Margin CKP PRICE HISTORY 30 25 20 15 10 5 Shares Short/Float 2009 2010 2011 THE BOTTOM LINE The company’s market position and anti-theft technology make it well-positioned to prosper as retail sales recover in developed markets and expand in emerging ones. accounting for about 75% of total expected revenues this year of $900 million.3% 4.0% 1.2% 12. Checkpoint and Sensormatic.6 13. he says. but increased production in Asia and South America should offset that and cause the overall global market to modestly grow. so we expect the PMC business to be a fairly reliable cash cow for years to come. Albany composites are already being used in wheel struts on the new Boeing 787. There’s clearly a tremendous amount of uncertainty about what and when planes get launched and reengineered. other publicly available information www. is selling anti-theft systems to retail stores. (@3/31/11): CKP 48.S. generating operating margins of around 25%. Broadly speaking.0% $707.5x our 2012 earnings estimate of $2. a division of Tyco. now at $26. He sees labeling as a logical Checkpoint Systems (NYSE: CKP) Valuation Metrics (@5/26/11): Business: Manufacturer of closed-circuit TV security systems and radio-frequency electronic tagging and detection systems used primarily by retailers to deter theft.64 16.7% Company Highlander Capital Shapiro Capital Earnest Partners Tocqueville Asset Mgmt Invesco Short Interest (as of 5/13/11): % Owned 24. Share Information (@5/26/11): Trailing P/E Forward P/E Est. and Europe to Asia. But it’s not beyond reason to think composites could be a $300-plus million business for Albany within the next decade. as well as about the traction the Leap-X engine gets in any of those programs. is likely to be flat. detection and video-surveillance equipment.00 0.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 17. which includes everything from price tags to the Levi’s label that gets sewn onto your jeans. and the company has done an excellent job shifting production capacity from the U.1 bilMay 27. The first. it’s an excellent business for Albany.07 – 23.9 S&P 500 16.9 14. On the current enterprise value of $1.I N V E S T O R I N S I G H T : Delafield Fund Is manufacturing paper-machine clothing a decent business? VS: It’s driven by paper production.7% 5.8x. which we think could have a great deal of upside. paper production in Europe is expected to decline and in the U. Our view is that the current valuation reflects no upside for the composite business.7 million 5. the stock today offers “highly compelling value. with margins comparable to those in paper-machine clothing. The second business is merchandise labeling. as well as a range of deactivation. says Dennis Delafield. while Sensormatic’s uses what is called acousto-magnetic technology.1 million $831. Two companies own the lion’s share of this business. This includes the hard and soft tags that are affixed to merINVESTMENT SNAPSHOT chandise. which is a consolidating and no-growth business in developed markets and a growing one – particularly in containerboard – in developing markets. Checkpoint’s is a radio-frequency-based system. but the most exciting potential is in providing composite-based parts to the Leap-X jet engine being developed for narrow-body planes by a joint venture between GE and the French company Snecma.50? VS: The shares trade at 11. Trading at less than 8x his estimate of the company’s pershare earnings power.6% 7. Competition in the business has become more rational as the industry has re-sized. While not exciting.2% 5.

4% 5. pigments. but this is a well-managed company with a sustainable franchise and a wonderful balMay 27. which the company has partly attributed to expenses related to new-product introductions.com Value Investor Insight 7 . Despite the short-term cyclicality.84 0. Its products include things like glazers. each division of the company has shown progressive operating improvement.6 13.7% 25 20 15 10 5 0 Revenue Operating Profit Margin Net Profit Margin FOE PRICE HISTORY 25 20 15 10 5 0 Shares Short/Float 2009 2010 2011 THE BOTTOM LINE Concern over near-term prospects for the company’s solar-energy-related businesses has caused the market to misprice – by valuing the shares at only 4. It will be that much better when retail spending around the world picks up. Given that Checkpoint’s tag technology is already radio-frequency based. Jim Kirsch. which is why earnings have been soft in the last few years. now trading at around $17. 2011 ance sheet. but also is a function of a mix shift to lower-margin systems as customers look to economize. The story now primary revolves around the company’s most-profitable business. that would translate into $1. enamels. (@3/31/11): FOE 38. we believe it’s logical to assume theft will continue to be a problem for retailers and that the sale of systems to prevent it will remain a good business in the future. it could generate sales of around $250 million this year.68 – 17. (NYSE: FOE) Valuation Metrics (@5/26/11): Business: Global producer of industrial chemicals and specialty materials used in a wide range of manufactured products. it should be a key player as that happens. anti-theft tags and the radio-frequency identification [RFID] tags used for inventory control will eventually merge in some way.3% Company Gamco Inv Lord. selling conductive pastes to the Ferro Corp. Since then. Describe your interest in diversified industrial supplier Ferro [FOE].25 per share. replacing top managers. They.0% 5. DD: Ferro produces specialty materials and chemicals used in a wide variety of manufacturing processes worldwide. says Dennis Delafield. Only after raising capital in a large and dilutive secondary offering in the fall of 2009 – in which we significantly increased our position – did the company have the financial breathing room for the restructuring to start paying off.3 9.5x estimated 2012 EBITDA on an enterprise value basis – the longer-term prospects for those same businesses and others in the company’s revived portfolio.5% 5. and we. After a recent acquisition. overhauled all aspects of the business – selling divisions. INVESTMENT SNAPSHOT The CEO since 2005. and inattention to cost control. it’s not unreasonable to expect earnings of closer to $2. and when retailers in general are investing in new technology.60? DD: The company’s goal is to get EBIT margins within the next couple of years to at least 10%. We don’t really work with target prices. other publicly available information www. On today’s revenue base. which we believe is realistic. through overexpansion.60 per share in earnings. The business may not bounce back right away. revamping sales efforts – just in time for the economic crisis to hit. Sources: Company reports.0% $1. We also can imagine that labels. They benefit when apparel and drugstore sales are strong. closing plants.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 12.8% 1.18 billion 8. Share Information (@5/26/11): Trailing P/E Forward P/E Est. but if earnings come through as we expect. What upside do you see in the shares.I N V E S T O R I N S I G H T : Delafield Fund strategic extension of the core business and has made no secret he wants it to be a $300-400 million revenue business in the near future. when stores are opening or refurbished. can certainly withstand another tough quarter or two.45 6.6% 6. plastics and solar-cell pastes. from wall coverings to solar cells. sticking with bad businesses for too long.valueinvestorinsight. Abbett & Co TIAA-CREF Vanguard Group BlackRock Short Interest (as of 5/13/11): % Owned 11. Margins have disappointed for two years. frits. This was a classic example of a company that had lost its way. but with growth over the next five years or so.4% 5. Is the business driven by retail sales? DD: Predominantly. today’s share price is likely to offer highly compelling value.08 billion $2.5 S&P 500 16.

valueinvestorinsight. How are you looking today at valuation? DD: At today’s price. Would it be fully priced at 7x EBITDA? That’s probably close.S. if at all. Non-VII subscribers still pay only $199. Ferro and Dupont are the two primary global producers of this paste. then.I N V E S T O R I N S I G H T : Delafield Fund solar-cell industry. The stock has been under pressure as investors are increasingly concerned about governments’ commitment worldwide to solar energy. are down some 30% in the past seven weeks. At what point would you consider a company like this to be fully priced? DD: The company’s operations have been vastly improved. you could be more or less fully invested all the time. We also think there are so many imponderables out there that it’s important to have a significant cash cushion in case something goes wrong. which have been cut back – or threatened to be – in countries that have to-date been the greatest solar proponents. without thinking about the state of the world. How big is that cushion today? DD: When I was first starting out in the business. which may both inhibit supply more than expected and put upward pressure on prices from historically low levels. There are only so many places you can put up wind turbines. nearly $130 million of it will come from the solar business. at just under $12. The best way to take advantage of a big market correction. for example. Subscribe Online » Mail-in Form » Fax-in Form » Want to learn more? Please visit www. solar is only economically viable as a power source with government subsidies. we’re closer to 20%. everything goes up and down at the same time. but you cannot be investing other people’s money unusual number of serious things to worry about.com Or call toll-free: NEW ISSUE OUT NEXT WEEK – DON’T MISS IT! 866-988-9060 *For current Value Investor Insight subscribers. We’ll miss some profits when valuations are running high and we’re raising cash. 2011 great confidence in management. the unemployment rate and the price of gasoline and what that means for consumer purchasing power. Is that concern being overdone? DD: In the short-term. That means EV/EBITDA on our 2012 estimate is only 4. www.S. That’s just not something we’ve ever worried about. so you don’t have stocks going up to sell in order to buy the bargains. is to have cash. How. There are also significant issues in getting at all the new shale natural gas reserves.5x. What’s going to happen in the Middle East? What’s going to happen in Japan? What’s going to happen with the U. we have no idea. and the business has taken off in the past several years along with spending on solar-energy technology.50. much of which is unsettling. the company’s enterprise value is $1. Of the $196 million in EBIT we expect Ferro to earn this year. Given the state of the world today. the best way to take advantage of a correction is to have cash.com Value Investor Insight 8 . you could sell the utilities you owned that were doing well to buy the beaten-down industrials. we’ll keep around 10% cash on hand for liquidity purposes. If there was a downturn in the industrial sector. and we have May 27. In today’s market. In a normal time. For the time being. government’s debt level and what happens if interest rates increase? Think about housing values. VII ON CASH: When everything goes up and down at the same time. including Germany. Spain and Italy. That all makes its way into the portfolio by our assessing the impact all of these things could have on each company we own and fully understanding the downside.35 billion. The shares.valueinvestorinsight. EBITDA next year can approach $300 million. are your views on today’s macroeconomic environment reflected in your portfolio? DD: We’re not macro people. But over time we believe solar energy – especially as costs to produce it continue to decline – will compete well against other sources of clean energy that governments around the world will continue to want to promote. We’re estimating that with continued improvement in the non-solar businesses and some modest upturn in solar revenues. Think about the U. it should have no net debt by the end of next year. dollar? There are an Expand Your Idea “Grapevine” Subscribe now and receive four quarterly issues of SuperInvestor Insight for as little as $149*.

joins a board or otherwise makes news. but not always. You joined your father’s investment firm in 1991.. Think McDonald’s.” Why did you gravitate toward a somewhat different value orientation? Lloyd Khaner: There are many ways to succeed in this business. rational competition and a strong balance sheet. but more about getting back to basics. thriving businesses that for some reason have hit a wall. you can have another chance. If it works. buying around $4 and selling above $20. she said she understood it was an accident and that they were still eating there as often as before. but my focus from early on has always been on companies that had proven. coli outbreak at their restaurants had killed four customers and made hundreds more sick. made up of what he considers first-class CEOs as well as their current or former top lieutenants. They have 25 to 30 years of experience. Thus he's quick to describe the profile of what he considers the ideal turnaround chief executive: “It's usually a first-time CEO. but people who have had success reliably put themselves in positions to continue to succeed. but more broadly. the payoffs can be much better over time than the 50-cent dollar going to a 80-cent dollar.” Value Investor Insight 9 . Think IBM. with her baby on her lap. whether his long-time gold bullishness is intact. It could be they got caught up in growth for growth’s sake and lost control of quality or operating discipline.I N V E S T O R I N S I G H T : Lloyd Khaner Investor Insight: Lloyd Khaner Lloyd Khaner of Khaner Capital explains the primary impediments to company turnarounds. but have never had a #1 spot before. while they've surely done very well financially. www. have proven business models. It’s not a question of creating something brand new from scratch. which they badly want. He's automatically pinged when anyone on the list takes a new position. coli problem and. But at the core are valuable competitive strengths that often. 2011 that this company had an opportunity to come back. There was obviously more to buying the stock than that. I was the first person from the buy-side or sell-side to visit the company after an E. but if you own up to them and make clear what you’re doing to make it right again. they’d switch off between one and the other.” he says.valueinvestorinsight. On the plane out to San Diego. between 48 and 52. they probably haven't yet had that huge payday. which is inherently risky. when it was focused mostly on deep-value “cigar butts. I asked what she thought about the E. She explained how she preferred Burger King. it hit home for me that in this country you can make bad mistakes. why investing in the Jack in the Box restaurant chain was a pivotal experience. “It's not fool-proof. require new management to bring back into focus. despite current challenges. took over Blockbuster and ran into a dying industry. The second is that the right management can make all the difference in whether the business comes back.” Khaner considers his best source of ideas to be the database of some 500 executives he's compiled since entering the business in 1991. I sat next to a woman with her baby who saw all the Jack in the Box material I was reading and asked if I was with the company. It could be that success had blinded them to changes in their markets that required bolder strategic or business-model adjustments. who turned around 7-Eleven and is the type of CEO we’d follow almost anywhere. “We're often happy to go along for the ride. Steven Spielberg's former production company. The immediate realization was May 27.com Lloyd Khaner Betting on the Jockeys Having earned a Masters degree in dramatic writing from New York University and spent time on a screenwriting fellowship at Amblin Entertainment. I took away two key lessons from that. an over-leveraged company and a financial crisis. established franchise even if a company loses its way. Cadence Design. One thing my father taught me at a young age was not to fall in love with companies or the people running them. but because her husband was a Jack in the Box fan. Jim Keyes. You look for companies that. but the company ended up doing the right things and the business came back better than ever. true value propositions. The strength of the franchise and the quality of management are what I spend most of my time on (see box). that was not going to be turned around. I don’t care how good he is. The first is that it takes a lot to kill a strong. One big influence for me was investing in the Jack in the Box restaurant chain in the early 1990s. Lloyd Khaner knows a thing or two about character development. have everything to prove and. reputation-wise. They're seeking out a challenge. I owned it for eight years. and what he thinks the market is missing in Sonic Corp. we’re also very clear on the fact that nobody’s going to turn around a bad company in a bad industry. What about Warren Buffett’s famous quote about which reputation remains intact if a great manager meets a bad business? LK: While we’re very managementfocused. Och-Ziff Capital Management and Illinois Tool Works.

primarily as a discipline to avoid buying too early.] Are you much slower to buy into the more arduous turnarounds? LK: Three-year to five-year turnarounds almost always require a deep infusion of outside management talent. but that’s not the type of thing I typically want to invest in. which we don’t at all believe will prove to be the case. but started getting interested when the company acquired business-process outsourcing leader Affiliated Computer Services 18 months ago. By the time I was convinced they were on the right track the stock was already up 50%. 87% of which are franchised. we want to see tangible evidence – say. When the stock got below $10 two years ago. for example. which is still the dominant part of the company. it can be quite slow to embrace it again. but we haven’t owned it for some time.valueinvestorinsight. and if that plan included shutting down the growth engine and even pulling back – which I thought was necessary – I wanted to see evidence of that actually happening before buying in. At 8x next year’s estimated earnings [based on a recent share price of just under $10]. [Note: Starbucks shares recently traded around $36. In something like that we’re prepared to invest fairly quickly and may exit fairly quickly as well. the Via instant-coffee line has been a big hit. but it’s often only after a year or two of careful study that we’re ready to act. but the stock is trading only marginally higher than it was then. April 28. Have you given up on that one? LK: We actually did OK on the stock when it ran up a bit in late 2006. There are so many alternatives and Campbell’s hasn’t come up with answers on the product side that have resonated enough with consumers to make a big difference. a change in culture. the market www. which will allow them to pay down debt and buy back stock. Store experiences have been improved. how demoralized the culture has become and how healthy the industry is.com . but the good news is I recognized the upside was much higher than a share price of $15. but that’s not something I’d want to bet on. We concluded that soup. declining inventory levels or reduced operating expenses – that the turnaround is working. and the international growth opportunity. In a one-year turnaround. how healthy the balance sheet is. and are really only in year two. after management at Jack in the Box told me they considered Sonic the gold standard in the industry for product innovation and operating excellence. If we believe the shares can double or triple if we’re right – which isn’t a stretch if earnings and valuations are starting from particularly depressed levels – we is valuing Xerox as if it were another Kodak. We bought six months ago and the stock has done nothing. early 2007. just isn’t as popular as it once was as a convenient meal. the problems have relatively recently surfaced. 2011 and some fairly dramatic shifts in operational execution.I N V E S T O R I N S I G H T : Lloyd Khaner Timing would seem to be of paramount importance in betting on turnarounds. it was just too early for me because the plan to fix things wasn’t yet clear. The time needed to get a company back on track is usually a function of how long the business has been struggling. an increase in gross margins. which has played out over several years. we have no problem leaving the first bump in the price on the table. executed by previous CEO Anne Mulcahy. How did the potential revival of drive-in restaurant chain Sonic [SONC] get on your radar screen? LK: I’ve paid attention to the company since the 1990s. particularly in China. We want to identify these potential turnarounds early. but we believe the catalyst will be 15-20% earnings growth over the next couple of years. Depending on the situation. How would you characterize your timing on Xerox [XRX]? LK: This is a case where we sat out the classic turnaround phase.500 restaurants. in retrospect. How do you think about that? LK: We actually categorize turnarounds as one-year. which you can’t overcome. an overhaul of the cost structure May 27. Is Starbucks [SBUX] a recent example? LK: This is one that. which acts like an anchor on companies that have to be so focused on keeping themselves afloat that they can’t or don’t do the operational things necessary to get back on track. with the largest concentration in the south cenValue Investor Insight 10 ON TIMING: If we believe the shares can double or triple. the balance sheet is still solid and the industry is in pretty good shape. There may be shortterm investment opportunity at times when an industry is in decline. We believe ACS is an excellent business and that the acquisition fundamentally changes the character of Xerox to something that is far more interesting than a company fighting against an inexorable decline in black-and-white printing. They’ve taken the McDonald’s turnaround playbook. there are more value-priced menu options. 2006] you identified Campbell Soup [CPB] as a long-term turnaround. We’re helped by the fact that once the market has given up on a company. What are the primary reasons companies don’t turn? LK: The first one is too much debt. When we spoke five years ago [VII.50. It has more than 3. three-year or five-year turnarounds. is tremendous. The second is a dying industry. have no problem leaving the first bump in the stock price on the table. we didn’t pull the trigger on quickly enough. The truth is they’d probably be better off as part of a bigger company. I don’t know what would make me interested again.

they’ll do it. Now trading around $11. closed poorly performing units. and a new Double Stuf Oreo ice cream dessert that I can attest is fantastic.86 0.5% 8. we think there’s a good chance the company can re-engage on unit growth and that they’re far from saturating their potential markets. LK: They stopped all new unit development. he expects $1 in estimated 2013 EPS to warrant a target share price of $18 within two years. They’re known for having better-quality food.1 21. with fewer players willing to be the price spoiler in a rising-cost environment. They have also carefully rethought pricing and now have a “laddered” menu with more of a value component to go with traditional premium items. Value Investor Insight 11 Largest Institutional Owners (@3/31/11): Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 11. Research and development for product innovation has been increased and they’ve again started to roll out exciting new products. Over the past three years the INVESTMENT SNAPSHOT company has endured the pain of repairing the damage. product innovation. which would result in a share price of $18. If you want Sprite and root beer and milk mixed together with crushed M&Ms.0% 5.valueinvestorinsight. Assuming solid comp-store sales growth and significant operating leverage. Now that store-level service has stabilized and is improving. We believe the turnaround inflection point here is upon us.com . increased base pay for company-owned store managers and stressed store cleanliness and efficiency everywhere. says Lloyd Khaner.28 – 11. and the company came out soon after the earnings call to say comp sales growth was accelerating and would probably reach 4-6% this year.35 in free cash flow per share. Describe the key elements of the turnaround plan.7 Russell 2000 49. the multiple could be even higher.5 22. 2011 www. 6inch all-beef hot dogs with ample top- Sonic Corp.6% 9. like a Spicy BBQ Burger. By then we’re estimating $1 in earnings per share and.3% 5. ultimately. (Nasdaq: SONC) Valuation Metrics (@5/26/11): Business: Operator or franchisor of more than 3. other publicly available information May 27. Sources: Company reports.5 pings for only $1.I N V E S T O R I N S I G H T : Lloyd Khaner tral and southeastern U.49 7. what upside do you see in the shares from here? LK: Assuming that comp sales grow 35% annually over the next three years and that operating leverage kicks in as revenues rise faster than costs and the company benefits from a unique ascending royalty-rate system – in which the percentage royalty paid by franchisees increases as sales rise – we expect annual bottom-line growth in excess of 20% through 2013. rising 13% on the day of the announcement.0% Company Fidelity Mgmt & Research Wellington Mgmt Invesco Dreman Value Mgmt Deustche Bank Short Interest (as of 5/13/11): % Owned 14. marketing effectiveness and. Share Information (@5/26/11): Trailing P/E Forward P/E Est. The stock was always too expensive until Sonic fell into the classic growth-forgrowth’s-sake trap. a wide beverage selection – nearly 40% of sales come from drinks – and for a willingness to customize any combination of food or drink on their menu.500 quick-service drive-in restaurants located primarily in the south central and southeastern United States. Last quarter comp sales at company-owned stores went positive for the first time in three years. profitability. This gives the customer more options and should help generate both new and repeat visits. car-hop service.0% $710. The stock responded nicely to that news. because the franchise model requires little in the way of capital spending.8 million 15. which resulted in kind of an across the board breakdown in operational control. SONC 26. I’d add that the general environment in the quick-service restaurant industry for passing on food and packaging cost increases is better today than it has been in years. What’s that worth? I think an 18x multiple on 2013 EPS is more than reasonable.1 million $543.8% 4.S. $1.9% 12. If unit growth re-accelerates.99.50.9% 20 Revenue Operating Profit Margin Net Profit Margin SONC PRICE HISTORY 20 Shares Short/Float 15 15 10 10 5 2009 2010 2011 5 THE BOTTOM LINE The market is underestimating the scope and speed of the company’s broad-based turnaround after it fell into a growth-for-growth’s-sake trap.

For clients around the world. 2011 This may provoke an admittedly selfserving answer. fixed income.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 14.9 S&P 500 16. importantly. As assets grow.1% 25 20 15 10 5 0 Revenue Operating Profit Margin Net Profit Margin OZM PRICE HISTORY 25 20 15 10 5 0 Shares Short/Float 2009 2010 2011 THE BOTTOM LINE Lloyd Khaner believes the company will be a prime beneficiary as institutional investors seek greater stability of returns and reallocate low-potential fixed-income holdings to alternative asset managers. What’s the investment case for one of your non-turnaround ideas. Some new blood is often important in refreshing and refocusing the overall leadership. led the turnaround. Share Information (@5/26/11): Trailing P/E Forward P/E Est. they offer the kind of “I can sleep at night” investment options that large institutions often crave. it operates four primary investment funds that employ a wide variety of strategies. Based on their strategy and backed up by strong historical performance. Based on “economic income. Is that unusual? LK: It can certainly happen. May 27. which Och-Ziff reached a long time ago. who has been Sonic’s CEO since 1995. That all makes for a highly scalable and profitable business.74 – 17.” which excludes non-cash charges from the reorganization it did prior to going public in 2007. special situations. other publicly available information www. For that. In general we’ve heard from clients that the company was highly transparent and responsive throughout the crisis.6 13. Sources: Company reports. they are paid on a traditional hedge fund scale. Cliff Hudson. they INVESTMENT SNAPSHOT never put up any “gates” to client withdrawals when the crisis was at its worst.valueinvestorinsight. long/short equity.5%. convertible and merger arbitrage. a reputation you want to have when managing other people’s money.3% (-31. we believe managers like Och-Ziff will prove to be a magnet for institutional assets. Their funds were down far less than the market in 2008. including convertible and derivative arbitrage. With interest rates and the prospects for capital appreciation so low. Och-Ziff Capital Management [OZM]? LK: Och-Ziff is one of the largest institutional alternative asset managers.6% 2. though. more than made up any losses in 2009 and.3% 5. pension funds and other similar institutions will have a hard time meeting obligations with too much fixed income. that he did over the last three years name a new head of company-owned stores. the company’s operating margins are in the mid-50% range and we believe are likely headed over 60% for the year ending in December. and he estimates they’ll earn a dividend yield on this year’s company earnings of 8. a new head of marketing and a new head of information technology.1% 2.I N V E S T O R I N S I G H T : Lloyd Khaner It’s interesting that the long-time CEO. People like Cliff.6% $1. Rowe Price Thornburg Inv Mgmt HSBC Holdings Century Capital Short Interest (as of 5/13/11): % Owned 3.59 11.56 3. Och-Ziff Capital Management (NYSE: OZM) Valuation Metrics (@5/26/11): Business: Investment manager offering a range of hedge funds focused on credit.8% 2. equity. hedge funds by and large protected investors much better during the financial crisis than non-hedged asset managers. expenses don’t at all grow commensurately once you reach critical mass.6%) Company Bank of NY Mellon T.3% 2. (@3/31/11): OZM n/a 9. It’s important to note. Another factor in favor of alternative managers is the fact that institutions have been sitting on very large fixed-income allocations that are going to have to be redeployed. In a world that financial-market-wise is not going to be a safe place for some time.5 million 51. don’t like losing and can bring a real fire to getting things back on track.41 billion $953. merger arbitrage and structured credit.com Value Investor Insight 12 . but what makes you optimistic about the future of the hedge fund business? LK: As evidenced by their performance. and private investments. earning an average 1. The shares currently trade at 55% of his $27 target price. The company runs truly “hedged” funds that typically have 120-130% long exposure offset with an 80-90% short exposure. with approximately $29 billion in assets under management.75% management fee and 20% of annual appreciation as an incentive fee.

it has to pay out a high percentage of its earnings as a distribution to shareholders. simulate and verify designs of a wide variety of semiconductors. describe your investment case for Cadence Design Systems [CDNS].07 0. I don’t have a crystal ball on this issue.8% 4. Assuming an 85% payout.1 million 2. cut costs.0 Russell 2000 49. With the shares at recent $14. participating in the company’s success in the same way we do. most of which are private equity firms.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 10. EDA software helps companies like Texas Instruments. than on incentive fees. At 13.I N V E S T O R I N S I G H T : Lloyd Khaner Inflows have been positive – hitting $2. other publicly available information www. This helps save time and money in the product-development process.2% 14. In OZM’s case. The 19 partners take no salary or bonus. In general.5%. Sources: Company reports.64 5. allowing them to see in advance things like how prospective new chips will perform. So using a more reasonable 15x multiple on our 2012 EPS estimate of just over $1.60 – down more than 50% from the 2007 IPO – how are you looking at valuation? LK: Wall Street assigns different multiples to alternative asset managers’ management-fee and incentive-fee streams. the shares within 12 to 18 months would trade around $17. there’s no reason why the company can’t manage more than twice the assets it currently does.2% 12 10 8 6 4 2 Revenue Operating Profit Margin Net Profit Margin CDNS PRICE HISTORY 12 10 8 6 4 2 Shares Short/Float 2009 2010 2011 THE BOTTOM LINE Having implemented a new revenue model. as shareholders receiving distributions and benefiting from any appreciation in the stock price. (@3/31/11): CDNS 19. We started tracking the company in 2007 when Lip-Bu Tan came off the Cadence Design Systems (Nasdaq: CDNS) Valuation Metrics (@5/26/11): Business: Global supplier of software and design tools that help engineers plan. May 27.9% 4. we get a target price of more than $27.0% $2. Ultimately.3%. Intel and Samsung design and manufacture computer chips and printed circuit boards. Share Information (@5/26/11): Trailing P/E Forward P/E Est. we believe money could come in at a much faster clip over the next couple of years. while the more volatile incentive fees earn more like 9x.8% Company Dodge & Cox T. because its incentive fees won’t be as volatile as those of other publicly traded alternative managers. and how much power they’ll use. The management fees might earn a 19x multiple.5x his 2012 earnings estimate. Rowe Price Wellington Mgmt Vanguard Group State Street Corp Short Interest (as of 5/13/11): % Owned 16. The biggest risks? LK: There is some risk that the hedge fund compensation model comes under attack. they have tended to let people get paid what they’re paid. whether they’ll be compatible within systems.5 22. and tailored R&D more to customer needs. 2011 Another thing I’d add is that the alignment of Och-Ziff’s partners here with those of shareholders is the best I’ve ever seen in my career. which are a much lower percentage of total revenue. because OZM is a master limited partnership.86 billion $980.8% 9. which is critical in an environment where the technology has to constantly evolve to meet the needs of end-product computer and smartphone manufacturers. which would affect the earnings available to shareholders. and on our 2012 estimate is 10.com Value Investor Insight 13 .5% 4. the company is well-positioned to benefit from what Lloyd Khaner expects to be a positive mobile-device-driven cycle for semiconductors. if people are satisfied with their returns.valueinvestorinsight. It’s obviously something we’re keeping our eye on. the dividend yield on our 2011 estimate is 8. LK: Cadence is a leading global supplier of electronic design automation (EDA) INVESTMENT SNAPSHOT software.7 billion last year for OZM – and while it’s impossible to be precise about timing. From hedge funds to software.7% 2. There is also a risk that the tax rate on “carried interest” is increased. but the company says they’ve had more pushback on management fees. On top of that.80.8 26.58 – 11. we believe the resulting blended multiple of around 13x is unfair. lay out. but those affected are likely to have up to a 10-year transition period to implement any change.

Management believes. What do you think the market is missing in Illinois Tool Works [ITW]? LK: This has always been a good company. while debt – most of which is in outof-the-money convertible shares – should only be around $600 million. We didn’t buy in until last year. with 800 operating companies aggregated into eight reportable segments: Transportation.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 56. In general. Pricing is more likely to remain rational as a result of consolidation and the fact that the shift to subscriptionbased revenue takes away some of the quarter-to-quarter jockeying to sign new business by making unprofitable price concessions.52 billion 15. Sources: Company reports.5% 3.4% $28. other publicly available information www.4% 2. we estimate Cadence can earn 90 cents to $1 in free cash flow this year and $1. What’s driving revenue growth? LK: The semiconductor industry is clearly volatile.com Value Investor Insight 14 . in a business where labor is the largest expense. Share Information (@5/26/11): Trailing P/E Forward P/E Est. and moving the revenue model to subscription-based payments over a contract life rather than one-time upfront payments. At 15x his 2012 per-share earnings estimate of $5. which would produce a share price in the next 12 to 18 months of around $17.33 – 58. How inexpensive are the shares at a recent $10.I N V E S T O R I N S I G H T : Lloyd Khaner board to run the company and began cutting operating expenses.8% 3.79 2. Is industry competition rational? LK: The EDA industry has consolidated into an oligopoly led by Cadence. Illinois Tool Works (NYSE: ITW) Valuation Metrics (@5/26/11): Business: Broadly diversified manufacturer of industrial products. margins and earnings per share over the next few years. It INVESTMENT SNAPSHOT should have almost $800 million in cash on the balance sheet by the end of this year. but we believe is about to prove it’s a great company.valueinvestorinsight.65? LK: We value the shares based on free cash flow. and we agree. which is higher than net May 27.1% 11.4% 60 50 40 30 20 Revenue Operating Profit Margin Net Profit Margin ITW PRICE HISTORY 60 50 40 30 20 2009 Shares Short/Float 2010 2011 THE BOTTOM LINE Having aggressively restructured itself during the economic crisis – including making new investments – the company is poised to “blow through” new records for revenues. though.5x the 2012 number is reasonable. Based on peer and historical multiples. The main risk short-term is that the semiconductor industry takes a turn for the worse. says Lloyd Khaner. It’s a multinational manufacturer of a wide range of industrial products and equipment. But we wouldn’t expect that to change the long-term demand picture for Cadence. operating through more than 800 decentralized business units worldwide. We consider Cadence a “picks and shovels” way to play that growth – it provides tools that semiconductor product manufacturers desperately need. Synopsys. that this should eventually be a 2530% operating-margin business.5% 3.5 billion $16.25 in 2012. systems and equipment. On top of that here we have costs having been cut and customers successfully migrated to higher-margin subscription contracts.99 40. we think margins are set to take off if revenues grow at the 10-15% annual rate we expect. Mentor Graphics and Magma Design. when we saw bookings start to grow again after a painful decline prompted mainly by the revenue-model switch. his target price for the shares is $75.8% 4. 2011 income because depreciation and amortization charges are roughly double capital expenditures.6 13. refocusing R&D based on closer customer contact. From 56 cents per share in 2010. and are comfortable the company can ride out any industry volatility. but it has less technology risk because they can stay device and end-market agnostic. but we think there’s a strong tailwind for the business from the current upturn in global technology spending and the explosive growth in mobile devices. operating leverage is very high.8 14. As a result. we believe 13. (@3/31/11): ITW 15.0% Company Northern Trust State Farm Vanguard Group Wellington Mgmt State Street Corp Short Interest (as of 5/13/11): % Owned 8.5 S&P 500 16.

While most companies fought to survive during the crisis of 2008-09. but I’d argue that ITW CEO David Speer. So what’s the “Wall of Worry” indicator saying today? LK: My latest list has 20 items. split roughly between organic growth and acquisitions. What assumptions are you making about profitability? LK: We’re assuming 10-15% annual growth in revenues. Real estate values propped the stocks up for some time.” Nice call – any similar insights today? LK: It’s not as much of a sector-wide bet. Applying that to our 2012 earnings estimate. and buying back its undervalued stock. Food Equipment. but I’ve found that when I can list more than 20 fundamental market concerns. but that hasn’t proven to be as valuable as people once thought. maybe significantly. we consider a 15x earnings multiple to be conservative. we think operating margins can top 18% by 2012. such as QE II going away. 2011 We’ve seen ITW show up on the ubiquitous “potential Berkshire Hathaway acquisition” lists that get published from time to time. There’s plenty to worry about – which may explain why I’m finding quite a few values out there. You also last time touted the virtues of gold. It operates in 57 countries. I still consider gold a good long-term hedge against inflation and geopolitical risk. From earnings of $3. No one has or will ask me. gold regularly had intrayear corrections of 20% or more two or three times a year – it is. who started at the company in 1978. which has turned out pretty well.com called “Lloyd’s Wall of Worry. With that growth and the permanent removal of costs in the restructuring.I N V E S T O R I N S I G H T : Lloyd Khaner Industrial Packaging. You write a column for Minyanville. ITW aggressively restructured itself through cost-cutting. would actually make a great choice as the next person to run Berkshire’s operations. the Middle East and Africa. now at around $57? LK: Given the 10%-plus revenue growth and 20%-plus EPS growth we’re expecting. Construction Products. saying “it’s not going to be pretty as housing prices and/or the economy go south. 32% from Europe. but have cut back. VII Value Investor Insight 15 ON GOLD: We still own it. which isn’t the case in shorting. What’s your take on it now? LK: We still own it. identifying the major things I believe are worrying equity markets worldwide. and All Other (which includes a thriving Test and Measurement business). is going to be successful over time. but I would not be surprised. a commodity. It’s ROIC averages 15-17% during cyclical upturns. Polymers and Fluids. with 48% of revenues coming from North America. we expect the company to set records for revenues. we might be due for one. Why do you think that is? LK: The main reason is probably that it’s a superb return-on-invested-capital company that often doesn’t get the respect it deserves from the market.com . Now we’ve had two years without a significant correction and. we’re estimating $4 this year and $5 next year. expanding through acquisition in higher-growth and higher-margin end-markets and geographies. It’s my way of putting somewhat of a macro overlay on my 100% company-focused investing. in an improving global economy where the dollar stops depreciating. www. you were betting against mortgage originators. our price target a year out is around $75.08 per share in 2010. May 27. rising oil prices or sovereign debt problems. I’d mention that I prefer to hedge using put options rather than shorting. How does that translate into potential upside for the shares. and 20% from Asia Pacific and everywhere else.” Why? LK: I’ve actually gone through the basic process for 20 years. residential and commercial construction – was still very weak. It’s not the only one we see in this boat. Revenues increased more than 10% in 2010.5 billion or so in free cash flow ITW will generate this year. A better reason to me is that the company follows the highly decentralized Berkshire operating model and does an excellent job of identifying accretive acquisitions. both of which are certainly on the table as management looks to allocate the $1. Options have their challenges because the pricing can be volatile – premiums for the most part are too high now – and because you have to get the timing right. after all. for example. even though that number gets hit by high levels of goodwill from the company having done so many acquisitions over time. As the global economy continues to mend. If I can identify no more than 10 big concerns. Decorative Surfaces. shortterm. the market is overly complacent. Power Systems and Electronics. That assumes no big stock buyback plans or a dividend increase. divesting underperforming operations.valueinvestorinsight. This is hardly scientific. but we like to know how much we can lose if we’re wrong. if gold prices stayed where they were or corrected.S. When we last spoke in 2006. but we’ve had two years without a significant price correction and we might be due for one. that high level of worry is usually priced into the market and it’s proven to be a good time to be looking for value. but we do believe certain retailers that have no real unique selling proposition and have too many stores that are too big – we call them “commodity retailers” – are going to get their lunch eaten longterm by online retailers and by specialty and discount stores. Until 2009. even though one key end-market – U. but it’s hard for us to see how Sears [SHLD]. margins and earnings over the next couple of years.

both based in France – when their stocks dropped like stones due to the European debt crisis. We had gotten out of ProLogis common stock. as a year ago we were able to buy some REITs – such as Unibail and Klepierre. we probably would have missed out on those before. because we had prepared for heavier investor redemptions than we got – and put it to work as security prices were so depressed. which don’t just disappear overnight. MW: In general. While no part of the market was spared.60 per share and we still think the stock is undervalued today at $19. “It was brutal for about a year. housing: “Are we going toward a model in which you need 20% down to purchase a home? If so … the housing market is likely to continue to suffer. that was bad news for the stocks of companies we owned like ProLogis [PLD] and Forest City Enterprises [FCE-A]. I believe we did a good job of staying focused on companies’ balance sheets. which were trading at 30. REITs. You’ve written about some process and portfolio-management changes sparked by the crisis. August 31. the premium we earn is an attractive yield on cash that is otherwise earning close to Value Investor Insight 16 . “There was no good news and companies that a year prior seemed to be wellmanaged and well-financed had their securities priced as if they were near bankruptcy. 2011 that create value. The storm clouds for real estate were gathering when we last spoke [VII. say. 50% debt to total assets based on value before the crisis suddenly were perceived to have 80% leverage as those values got marked down. Even after enduring tremendous pain with our investment in Forest City.com and return expectations.valueinvestorinsight. but bought back in as the share price got as low as $2 – we recently sold it above $14. companies with high development exposure took particularly big hits as the perceived value of the projects declined sharply. This has already proven helpful. from 12-13% or higher before the crisis. 40 or 50 cents on the dollar.S. Because of the suddenness of the crisis. When credit markets shut down. but we’re much less apt today to let a 5% position through appreciation become an 8% position unless its prospective return has commensurately improved as well. How do you think your strategy weathered the ultimate deluge? Michael Winer: Nothing has caused us to question the fundamental aspects of our strategy. the long-term value of the assets they owned and on consistent. If the options expire out-of-the-money. and a year later were typically able to sell them at par. We invested heavily in the unsecured convertible notes of U. What’s behind that? JW: When markets are volatile and option premiums are high. we asked Winer and co-portfolio manager Jason Wolf – who oversee $5. We’re not at all becoming market timers. We’ve also scaled back the maximum position size we’re comfortable with to 8-9% of the portfolio. You’ve started selling out-of-the-money put options on some of the stocks on your prospect list.” With most residential and commercial real estate markets having only tentatively begun the recovery process.” he says. we’ve taken a more active view on adjusting position sizes so they best reflect our level of conviction www. We can only do this when we have a relatively high cash balance to cover purchases we might have to make – today cash is around 22% of the portfolio – and we see it as sort of a win-win proposition. Describe those. Michael Winer admits to some surprise at the ferocity of the recent downturn. Jason Wolf: Another important change we’ve made is to develop a well-maintained list of companies we would want to own at the right price. We focus on development-oriented real estate operating companies May 27. We had some pretty decent cash reserves in late 2008 and early 2009 – around 18% of the portfolio. there were so many securities on sale that we were a bit paralyzed in trying to analyze them all. we can essentially pick the price at which we’d buy a stock that’s trading at a discount to our estimate of net asset value and receive a nice premium for agreeing to buy it at that lower price in the future. Companies with. We’ve made the investment to stay current about on-deck ideas so we can act more quickly when opportunities present themselves. for example. For Third Avenue Funds' Michael Winer and Jason Wolf that spells selective investment opportunity – leavened with a heavy dose of caution.” Editors’ Note: Even for the boom-andbust real estate business in which he’s plied his trade for the past 25 years. Jason Wolf Third Avenue Management On U. recurring cash flows.S T R A T E G Y : Real Estate Rebuilding The recovery in most global real estate markets has been fitful at best. 2007]. we participated in its equity raise at $6. INVESTOR INSIGHT Michael Winer.5 billion in real estate-related investments for Third Avenue Management – for insight on where they’re finding opportunity today … and where they aren’t.S. as opposed to most real estate investment trusts [REITs] that buy properties and then try to make money on the spread between financing costs and the assets’ yields. Given how quickly the shares came back.

If the shares are put to us. but there’s a lot of leverage there once they are able to spread selling. a natural disaster or a major market dislocation – could cause us to have to buy a stock at a premium to the market price. They just seem priced for perfection right now. Are we going toward a model in which you need a 20% downpayment to purchase a home? If so – and I’m making no value judgment at all – the housing market is likely to suffer for another couple of years. You’ve been through the wringer with long-time holding Forest City Enterprises. As long as the stock stays above $14 or so. the company has recreated its former distressed-real-estate business under the Rialto Capital banner. Whole Foods and National Amusements. of the $750 million of corporate-level liabilities. given the notoriously tight Manhattan rental market. In addition. the vast majority of it is in single-property.” Is that still true? MW: The news every month on U. some $470 million of that is in convertible debt that is all inthe-money. retail and residential projects. NY called Westchester’s Ridge Hill. JW: The big unknowns. as they’re trading in the U. which we go to great lengths to mitigate by focusing on margin of safety and rocksolid balance sheets. This significantly reduces risk – if a troubled property has a $100 million mortgage and is only worth $60 million. who founded Rialto with Lennar’s backing. so the answer is yes. MW: The other big knock on Forest City is that it’s perceived to have a relatively high debt load. for a large cineplex. housing isn’t encouraging. we’re paying less than our “buy price” after netting the premiums against the strike price. but we think we’ve seen the bottom and long-term we’re bullish. low levels of current housing starts and obsolescence of existing stock. of course.S. we believe can surprise on the upside in terms of rents and occupancy rates. We're confident that there will ultimately have to be a greater number of homes built in the U.. 8 Spruce Street will be worth a lot more than that. but it’s hardly a disaster and one day. as evidenced by the fact that they’re earning 18-20% gross margins on the homes they’re selling today. They have smart management. 2011 Why is Lennar [LEN] one of your key bets on a cyclical rebound? MW: Like everyone else.S. One is 8 Spruce Street.S. The first is that there’s uncertainty over some remaining big development projects and how well they’ll get operationally up to speed. We were actually an original shareholder in LNR Property Corp.S. as a nice counterbalance against a prolonged bottom in the housing market. The risk. based on its overall debt to total assets. in particular at all-time high multiples of cash flows and all-time low implied cap rates. is going to look like. He’s buying portfolios of distressed mortgages from failed banks and the FDIC and we expect that he’ll again create meaningful value for Lennar shareholders. For one. Lennar has struggled in the downturn. www. including Lord & Taylor. which over 40 years has created value through a wide variety of large-scale. The project is scheduled to be completed this year. offers great views and will even have a new public school built on the ground floor. are what’s going to happen to Fannie Mae and Freddie Mac and what the new mortgage model in the U. They usually do better. Value Investor Insight 17 . which will be the tallest residential building in New York City. On top of that. non-recourse-to-the-parent mortgage loans. given positive household formation. That is not at all the case today in our view. When we last spoke you were wary of U. it will probably be worth about the $950 million they paid to build it.S. but we expect it to be one of the most-profitable builders as conditions improve.com There are two knocks on the company today from the market’s perspective. At the end of the day when it’s stabilized.valueinvestorinsight. Does your current cash level reflect caution about today’s environment? MW: We consider having 10% cash to be fully invested. with a non-recourse loan you really only owe $60 million because you can hand the keys back. a 76-story apartment complex designed by Frank Gehry.. which is another reason we like Lennar’s stake in Rialto. of course. that debt will be turned into equity over time. The retail environment has improved considerably over the past six months and they’ve signed some key tenants. general and administrative costs over a larger base of sold homes. saying “I just don’t know where the bottom is yet. income-producing commercial. May 27. but we’ll own them if the prices are right. Operating margins are still skinny. What is your take on the company’s prospects today? JW: Forest City to us is the quintessential real estate development company. Dick’s Sporting Goods. We’re seeing more selling opportunities than buying opportunities.S T R A T E G Y : Real Estate zero. so we’re unapologetic about holding cash as dry powder. Homebuilders by and large have written down their land inventories to appropriate levels. is that an exogenous event – like fraud. That’s a real wildcard. often as part of complicated urban-development projects. great land assets on the books at low values – either from writedowns or from opportunistic acquisitions in recent years at bargain prices – and plenty of cash to ride out current conditions. Ridge Hill opens in phases over the next two years and if the economy remains reasonably healthy. But we think those concerns are overblown if you look more closely at the type of debt the company has. homebuilders. Another development underway is a $1. the similar business that was spun out of Lennar in 1997 and run very successfully by Jeffrey Krasnoff.3 billion retail mall development in Yonkers. I mentioned that commercial REITs aren’t typically our focus. Our view is that we already assume those types of risks with every security we own.

we use book value less 10%. than in it? JW: North America represents just over 30% of the portfolio today. MW: If we applied the current implied cap rates on comparable publicly traded REITs – which we believe are somewhat overvalued – to Forest City’s income-producing properties.92 10. although we’ll accept less of a discount if the growth potential is high. For the income properties.18 billion 22. but investors appear hesitant to bid up stock prices. historic preservation and the creation of waterfront open space.2% 5. which we believe is likely.8% 7. as they put their 8. Describe why Henderson Land [12:HK] is a prime example. we assume 7% cap rates on current net operating income for the retail. primarily Asia exJapan. we estimate NAV at $22-23 per share.90.600-acre land bank across the country to good use and continue to be the preferred developer for transformative urban projects. and some other hotel and military-housing assets. Do you still find more opportunity outside the U. The upside to that. and subtract the debt. we’re just finding better pricing in Asia. (@3/31/11): FCE-A 62. encompassINVESTMENT SNAPSHOT ing commercial development. That to us signals phase one of the recovery. in that the mostdeveloped real estate public-security markets like the U. its net asset value would be closer to $30. But we also believe there will be a phase two.2 n/a S&P 500 16. In Forest City’s case.K. the NAV would be closer to $30 per share.6 13.8% 6.42 0. We’re seeing a disconnect between market fundamentals and valuations.0% $3. The company was recently chosen for the Pier 70 project in San Francisco.valueinvestorinsight.S. office and residential portfolios. we value separately the income-producing properties. is if the development portfolio and the land bank prove to be worth far more over time than the book value minus 10% we’ve assumed. other publicly available information May 27.80 – 19. For the hotel and military assets. generally have fair to high valuations paired with anemic real estate fundamentals.3% 9. We’re interested when the shares trade at least at a 20% discount to that conservative estimate. the development portfolio. Share Information (@5/26/11): Trailing P/E Forward P/E Est.1% 7. Sources: Company reports.16 billion $1. including cash. JW: The company was founded in Hong Kong in 1976 by Lee Shau Kee [#28 on Forbes’ list of the world’s richest people] Value Investor Insight 18 Forest City Enterprises (NYSE: FCE-A) Valuation Metrics (@5/26/11): Business: Commercial and residential real estate development. As value investors.0% 8. says Michael Winer. Your portfolio has been weighted toward international stocks for some time. When you add it all up. we use an even higher cap rate of 9%.5 Largest Institutional Owners Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 18. For the development portfolio and the land assets. the land bank.com .0% Company Third Avenue Mgmt Horizon Asset Mgmt Morgan Stanley Inv Mgmt Wellington Mgmt Cohen & Steers Short Interest (as of 5/13/11): % Owned 13. 2011 www. the company’s development assets as a percentage of total assets goes to less than 10%. with specialty in urban renewal projects done in concert with municipal or regional governments. supply and cash flow fundamentals. If he applies the current implied capitalization rates on comparable publicly traded REITs to the company’s assets.S T R A T E G Y : Real Estate Is the development pipeline fairly empty after those two projects are stabilized? JW: As those two projects become operational. and that’s all we’re counting on in finding the stock attractive today. you have great demand.8% 50 40 30 20 10 0 Revenue Operating Profit Margin Net Profit Margin FCE-A PRICE HISTORY 50 40 30 20 10 0 Shares Short/Float 2009 2010 2011 THE BOTTOM LINE Concern about near-term prospects for soon-to-be-completed development projects in and around New York City is unduly penalizing the company’s stock. while in the developing world. That’s the type of complex project Forest City does very well.S. how are you looking at valuation? JW: In valuing companies we typically use what we think are very conservative cap rates on each component part of net operating income to arrive at gross asset value. and the U. With the shares at $18. then subtract all liabilities to arrive at net asset value.

one of Asia’s largest and most-profitable natural gas distributors which also owns two-thirds of Towngas China. Henderson is unique in not participating in public auctions for land. Our view is that based on the company’s actual portfolio makeup. encompassing some 15 million square feet of owned space.valueinvestorinsight. The development business is sort of a catch-all for a giant portfolio of raw land. other publicly available information www.com Value Investor Insight 19 . which we consider one of the highest-quality real estate projects in the world. isn’t one concern that it will act aggressively to rein it in? JW: That is clearly a primary reason investors appear so cautious. The most valuable is its 40% holding in Hong Kong & China Gas. now trading at HK$51. which sounds low. That has translated into excellent cash flow growth from this segment. We value separately the company’s 35% equity interest in Hong Kong’s International Finance Center.78): Financials (2010) Revenue Operating Profit Margin Reported NAV/Share Valuation Metrics (Current Price vs. at current market prices. he pegs the net asset value of the company’s shares at HK$70.09 Price 52-Week Range Dividend Yield Market Cap HK$51. Walk through your sum-of-the-parts valuation of the company’s stock. mostly because of the very low farmland and raw land prices on the books. Based on what he believes are conservative sum-of-the-parts assumptions. It has been selling residential properties in Hong Kong. 35% above today’s price.5 billion P/E 12:HK 7. The income-property portfolio. Hong Kong Ferry and Miramar Hotel & Investment.6 HENDERSON LAND PRICE HISTORY 80 70 60 50 40 30 20 2009 2010 2011 80 70 60 50 40 30 20 THE BOTTOM LINE There’s a disconnect between the company’s current valuation and the supply/demand and cash flow characteristics of its properties and markets. With government policy having helped fuel the real estate boom in China. that’s worth just under HK$21 billion. which will probably lead to a banner profitability year in 2011 if that pace continues. which has resulted in it accumulating over the years particularly low-cost assets. that generic risk is overstated in Henderson’s case. At the May 27. primarily in Hong Kong and second-tier cities in mainland China. real estate development projects in Hong Kong and mainland China.75. but is actually conservative for the Hong Kong market. entitled land.1 S&P 500 16.2% HK$73.09 billion 36. 2011 same time. The portfolio of stock holdings are worth another HK$55 billion. which haven’t seen house prices go parabolic and which will continue to benefit from strong demand as the flight from country to city continues. farmland. a discount to actual market values due to potential liquidity issues if they tried to sell their stakes. The Hong Kong & China Gas stake alone. particularly in the retail and office sectors. retail and residential real estate properties.and third-tier Chinese cities. and several urban redevelopment projects. a public gas utility operating in 17 provinces in mainland China. regardless of the fundamentals. Exchange Rate: $1 = HK$7.75 HK$43. Henderson Land (Hong Kong: 12:HK) Business: Develops and operates commercial. We assign a HK$78 billion value to the development assets. is worth 55 billion Hong Kong dollars.S T R A T E G Y : Real Estate and consists of income-producing properties primarily in Hong Kong. a 16% premium to book value. averaging 10% annually over the past six years.1 billion Hong Kong dollars. That results in a value for that piece of HK$42 billion. its residential holdings tend to be located in second. Two of the publicly traded stakes the company owns are in small-cap real estate companies. Its commercial assets on the mainland are in high-quality urban office and retail properties that haven’t shown the pricing excesses you do see in “tier-1” city residential properties. JW: The net operating income for the income-producing properties is around 2. 45% of Henderson’s entire market cap. for example. Henderson also actively sells properties when it believes the time is right. says Jason Wolf. TTM): HK$7. and stakes in separate publicly traded companies such as Hong Kong & China Gas.50 1. We value INVESTMENT SNAPSHOT that cash flow at a 5% cap rate. is benefiting from high demand and relatively constrained supply in Hong Kong.10 – HK$61. Using only book value. unsold or unfinished office property. Sources: Company reports.9% HK$121. Share Information (@5/26/11.

But there’s no question it’s a terrible market right now. Joe [JOE]. Is this a case where the ultimate payoff is just too far off. VII May 27. If new management articulates a plan that we trust will realize the value in the company. with [Fairholme Fund’s] Bruce Berkowitz taking over as chairman and overhauling the board and management. which should serve them quite well if we get into an inflationary period. we’ll choose to be on the sidelines. MW: We no longer own St. If you strip out the actual value of the Hong Kong & China Gas stake. One technical issue weighing on the stock is a “bonus warrant” the company issued to shareholders last year. Rents in such cases should follow the inflation trend and to the extent you’ve locked in long-term fixed-rate debt financing. we believe we’re buying the real estate at a 50% discount to net asset value. even though the stock was then trading around HK$53. apparently trying to send a message about his confidence in the company. recently exercised his right to buy shares for HK$58 each. and more importantly. which expires in June. we don’t know what the business plan will be and who’s going to execute it. or HK$70 per share. While [Greenlight Capital’s] David Einhorn has some valid arguments to the contrary. and we arrive at a net asset value for the company of HK$160 billion.com Value Investor Insight 20 . most of that inflation falls to the bottom line.70]. we don’t mind waiting for years to get at it. Joe shares. but it rein- forces our belief that investor sentiment on this stock is way too negative. How should investors fearful of inflation think about investing in real estate? MW: Well-leased and well-located real estate should be a hedge against inflation. We certainly wouldn’t do that. allowing it for twelve months to buy newly issued shares at HK$58 per share. That has not surprisingly put a lid on the share price. We have to ask about your take on the drama at Florida real estate company St. An interesting twist of late is that Lee Shau Kee. we’d be happy to buy back in. since no new investor would want to pay more than that when current investors have that option. As long as that’s the case. subtract HK$51 billion in liabilities. we do believe the long-term value is there. If the potential upside is big enough. maybe even at today’s price [of $21. even for you? MW: I wouldn’t say that.S T R A T E G Y : Real Estate Add in another HK$14 billion for various other assets and cash. Most of the companies we own continue to refinance their debt at low rates with extended maturities.valueinvestorinsight. We think the new airport is going to be a tremendous asset for northwest Florida and that the market will eventually recover. 2011 www. in which you were once the largest shareholder.

Add it all up and he estimates the company can earn $2 per share within the next two to three years. Though hardly good news for Skechers – toning shoes accounted for an estimated 20% of the company's 2010 revenues of $2 billion – David Kessler of Robotti & Co.6% 16. The culprit: a rapidly cooling market for so-called “toning” sneakers.70 17.6 13. it’s highly unlikely the shares will be such a bargain.S. thicksoled shoes with rounded heels that had taken off in popularity when Skechers entered the market in 2009 with its lowerpriced Shape-Ups line. trend-conscious shoe company Skechers has built a nicely profitable and well-diversified franchise. INVESTMENT SNAPSHOT The potential stock upside? Shoe companies such as Nike. Applying a less-than-market multiple to that. but they never dry up completely. Looking forward. 2011 rest of the business – from international expansion and opening 25-30 new U.7% 50 40 30 20 10 0 Revenue Operating Profit Margin Net Profit Margin SKX PRICE HISTORY 50 40 30 20 10 0 Shares Short/Float 2009 2010 2011 THE BOTTOM LINE With solid revenue growth in the rest of its business offsetting fading toning-shoe sales. which he does not think will go entirely away. the company increased revenues at an 8% annual clip. While capable of creating its own product hits. It spends heavily on celebrity-endorsed advertising and then takes full advantage of its strong distribution network of independent retailers and nearly 300 company-owned stores. Skechers bread-andbutter has been quickly adapting others’ trendy products into stylish footwear sold at mid-tier prices. but it's not.2% 6. Sources: Company reports.4 16.7 S&P 500 16. “The next couple of quarters may not be pretty. Since topping out near $45 a year ago.90 0.41 – 44. “But once the inventory issues are resolved and attention shifts back to the core business. Share Information (@5/26/11): Valuation Metrics (@5/26/11): Trailing P/E Forward P/E Est. the company can earn $2 in EPS in the next two to three years.S.5% 4. stores per year – will offset the decline in toning-shoe revenue. Deckers and Wolverine trade today at 18-20x earnings.valueinvestorinsight.99 billion 6. designer and marketer of casual footwear sold through independent retailers and company-owned stores.3 million $1. other publicly available information www. says David Kessler.com Value Investor Insight 21 . earned consistent gross margins in the low-40% range and averaged 13% returns on equity. He expects marketing spending to be maintained at a high 9% of revenues. but believes operating margins can increase to around 8%.U N C O V E R I N G V A L U E : Skechers Best Foot Forward After nearly 20 years in business.5 Price 52-Week Range Dividend Yield Market Cap Financials (TTM): 17.” VII Skechers (NYSE: SKX) Business: U.70 after the company reported three straight quarters of unexpectedly high inventories and unexpectedly low earnings. Fashion-forward shoe company Skechers finds itself among this unhappy cohort today.” he says.6% Largest Institutional Owners Company Wellington Mgmt Cadian Capital Perkins Inv Mgmt Short Interest (as of 5/13/11): % Owned 7. driven by operating leverage and savings from a new distribution center opening this year. but even at 13-15x his estimate of “normal” EPS – plus more than $2 per share in net cash on the balance sheet – Skechers' shares would be worth closer to $30. its stock now sits at a recent $17. the shares would be worth closer to $30.3% 5. such as the Twinkle Toes line of kids' shoes. Lists of stocks hitting new lows may shrink. “The market's reaction implies the company is a one-trick pony.0% $881. Kessler believes 68% average annual top-line growth in the May 27. toning shoes day in the sun appears to have passed. (@5/26/11): SKX 9. As claimed benefits ranging from reduced cellulite to improved circulation have come under increased scrutiny. believes the decimation of its share price has been overdone. In the ten years before toning shoes came along.” says Kessler. So why is the market treating it as a troubled one-hit wonder? Such is the nature of dynamic economies – and fickle investors – that even the strongest bull markets bypass certain stocks entirely.

I'd say it's “cheapness. President and Co-Editor-in-Chief. display or editing of the Content by any means. Whitney Tilson. by Value Investor Media. transmission.valueinvestorinsight.valueinvestorinsight.” a much less dependable activity. Contact Information: For all customer service. people have been asking me for the secret to risk control. The competition in making purchase decisions is too good.” Keep it simple. please visit www. In the article. telephone: 703-288-9060 May 27. Vienna. ©2011 by Value Investor Media. Tommy Armour says. Inc.S. All Site content is protected by U.valueinvestorinsight. in his latest investor missive he responds to those wanting the Cliffs Notes version of his new book by further narrowing the field of “most-important” things on which investors should focus: Especially since the publication of my book. in a Loser's Game. Without doing the above. Annual subscription price: $349.com (the “Site”). Almost all of the really big trouble that you're going to experience in the next year is in your portfolio right now. titled “The Loser's Game. “investing” moves closer to “speculating. and international copyright laws and is the property of VIM and any third-party providers of such content. if you could reduce some of those really big problems. to a Loser's Game.” Armour again: “Simplicity. deliberate actions of a privileged view could generate consistent outsized returns.” Concentrate on your defenses. The numbers made a good case for passive investing. Inc.” Ramo says: “Every game boils down to doing the things you do best. Terms of Use: Use of this newsletter and its content is governed by the Site Terms of Use described in detail at www.valueinvestorinsight.” investing legend Charles Ellis argued that increased competition among highly skilled professional investors had turned investing from a Winner's Game. while others lost their way to glory by wandering in a maze of details. historian Admiral Samuel Elliot Morrison and professional golf instructor Tommy Armour. If I had to identify a single key to consistently successful investing. The Most Most Important Thing Speaking of Howard Marks. limiting risk and minimizing losses. 2011 » » » Or call toll-free: 866-988-9060 Want to learn more? Please visit www. but citing his own experience and the work of scientist Simon Ramo.com www.EDITORS’ LETTER Winning a Loser’s Game Oaktree Capital Chairman Howard Marks often credits a 1975 article in The Financial Analysts Journal as a key contributor to his investment thinking.S. Suite 400. preferred by oneself. he wrote.valueinvestorinsight. Chairman and Co-Editor-in-Chief. Admiral Morrison says: “Impose upon the enemy the time and place and conditions for fighting Value Investor Insight™ is published monthly at www. you might come out a winner in the Loser's Game. Ellis does offer some specific advice (which we've condensed here) to those determined to try to win the Loser's Game: Be sure you are playing your own game. mechanical or electronic. John Heins Co-Editor-in-Chief Whitney Tilson Co-Editor-in-Chief Always on the lookout for better investment ideas? Subscribe now and receive a full year of Value Investor Insight – including weekly e-mail bonus content and access to all back issues – for only $349. 90 percent of all research effort should be spent on making purchase decisions. It's not the only thing that matters – obviously – but it's something for which there is no substitute. Copyright Act imposes liability of up to $150. concentration and economy of time and effort have been the distinguishing feature of great players’ methods. in which the aggressive. Know your policies very well and play according to them all the time. “Play the shot you've got the greatest chance of playing well. John Heins.com Value Investor Insight 22 . See a summary of key terms on the following page of this newsletter. VA 22182.com. or contact us at Value Investor Insight. subscription or other inquiries. Concentrate on selling instead. and doing them over and over again.000 for each act of willful infringement of a copyright. 2071 Chain Bridge Road. The U. In a Winner's Game. where the emphasis must shift toward making fewer mistakes than others.” Simon Ramo suggests: “Give the other fellow as many opportunities as possible to make mistakes. hear.com. Any other reproduction. without the prior written permission of VIM is strictly prohibited.” Buying at low prices relative to intrinsic value (rigorously and conservatively derived) holds the key to earning dependably high returns. most researchers should spend most of their time making sell decisions. Hear. and he will do so. All rights reserved. That’s less than $30 per month! Subscribe Online Mail-in Form Fax-in Form Subscribers may download Site content to their computer and store and print Site materials for their individual use only.

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