Value investing congress notes

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1 Value Investing Congress October 19 th and 20 th , 2009 Marriott Marquis, Times Square Notes by Nick Rugoff [email protected] -Bill Ackman Pershing Square, L.P. : Prisons’ Dilemma (pg. 3) -Alexander Roepers Atlantic Investment Management: Atlantic’s Approach to Value Investing (pg. 24) -Julian Robertson: Q&A (pg. 35) -Sean Dobson Amherst Securities: “Fishing in a Poisoned Pond” – Analytic Methods for Distressed RMBS Investing (pg. 40) -Lloyd Khaner Khaner Capital: Management, Management, Management – The Key to Turnarounds (pg. 57) -David Einhorn Greenlight Capital: Liquor Before Beer, In the Clear (pg. 65) -Eric Sprott Sprott Asset Management: The Financial Crisis Isn’t Over (pg. 71) -Zeke Ashton Centaur Capital Partners: Stocks the Rally Left Behind (pg. 84) -Jason A. Stock & William C. Waller M3 Funds: Banks & Thrifts: Opportunities in a Troubled Sector (pg. 95) -Whitney Tilson & Glenn Tongue T2 Partners: More Mortgage Meltdown & A Stock Idea (pg. 105) -Kian Ghazi Hawkshaw Capital Management: Kicking the Tires (pg. 137)

Transcript of Value investing congress notes

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Value Investing Congress October 19th and 20th, 2009

Marriott Marquis, Times Square

Notes by Nick Rugoff [email protected]

-Bill Ackman Pershing Square, L.P. : Prisons’ Dilemma (pg. 3) -Alexander Roepers Atlantic Investment Management: Atlantic’s Approach to Value Investing (pg. 24) -Julian Robertson: Q&A (pg. 35) -Sean Dobson Amherst Securities: “Fishing in a Poisoned Pond” – Analytic Methods for Distressed RMBS Investing (pg. 40) -Lloyd Khaner Khaner Capital: Management, Management, Management – The Key to Turnarounds (pg. 57) -David Einhorn Greenlight Capital: Liquor Before Beer, In the Clear (pg. 65) -Eric Sprott Sprott Asset Management: The Financial Crisis Isn’t Over (pg. 71) -Zeke Ashton Centaur Capital Partners: Stocks the Rally Left Behind (pg. 84) -Jason A. Stock & William C. Waller M3 Funds: Banks & Thrifts: Opportunities in a Troubled Sector (pg. 95) -Whitney Tilson & Glenn Tongue T2 Partners: More Mortgage Meltdown & A Stock Idea (pg. 105) -Kian Ghazi Hawkshaw Capital Management: Kicking the Tires (pg. 137)

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-David Nierenberg The D3 Family Funds: D3 War Stories: Practical Lessons About Building and Protecting Shareholder Value by Improving Corporate Governance (pg. 154) Candace King Weir & Amerlia F. Weir Paradigm Capital Management – Bottom-up Stock Picking: Back in Fashion? (pg. 163) -Paul Isaac Cadogan Management: Investing as a Pari-Mutuel Proposition (pg. 167) -Joel Greenblatt Gotham Capital: Formula Investing with a Value Mindset (pg. 171)

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Bill Ackman Pershing Square, L.P. : Prisons’ Dilemma Bill Ackman is is the Managing Member and General Partner of Pershing Square, L.P. Prior to forming Pershing Square, he cofounded Gotham Partners, L.P. in 1993, a public and private equity investment partnership. Mr. Ackman earned an MBA from the Harvard Business School. Corrections Corporation of America: Ticket: CXW Stock price: $24.50 -Corrections Corp owns and operates private prisons -Owns the land and buildings at most of its facilities -Largest private prison company -Fifth largest prison manager behind California, Capitalization: -Enterprise value: $4.1 billion -Equity market value: $2.9 billion Recent valuation multiples: -2009 e Cap rate: 12.2% -2009 P/Free Cash Flow Per Share: 13.3x CXW operates its business in two segments:

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Strong national footprint:

Tenants are unlikely to default as the consequences of default let your prisoners lose

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CXW is the clear leader in privatized prisons, controlling approximately 46% of the private prison and jail beds in the US:

CXW addresses a total U.S. market that exceeds $65 billion, of which only approximately 8% is outsourced. Privatized beds have grown from nearly 11,000 in 1990 to over 185,000 today (17% CAGR).

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Public-sector correctional systems are currently operating at, or in excess of, design capacity: -19 states were operating at 100% or more of their highest capacity measure (29 states were operating at 100% or more of their lowest capacity measure) -In total, state prisons were operating at 96% of their highest capacity measure and 113% of their lowest capacity measure -The Federal prison system was at 137% of capacity California prisons are running at 170% of designed capacity:

Competitive advantage in state vs. private: -CXW has historically outperformed the public sector in safety and security

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-As a private company, CXW has cost and efficiency advantages compared with its largest competitor (the US government):

Increasing market penetration: -Because of constraints in new public prison construction, private prison operators were able to capture 49% of the incremental growth in U.S. inmate populations in 2007

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-Historically, inmate populations in the U.S. have grown regardless of economic factors:

Prison populations are expected to rise:

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Federal demand drives growth: -Federal demand alone could fill CXW’s approximately 12,000 bed inventory over the coming years - The Federal Bureau of Prisons (“BOP”) is currently operating at 137% of rated capacity, with a stated desire to operate closer to 115% - The BOP projects that between 2008 and 2011 its population will grow by ~19,000 inmates, with just over 12,000 new beds planned for development by 2012 -The United States Marshals Service (“USMS”) has a population of about 60,000-65,000 and has grown 8%-10% per annum over the last five years -Since 1994, Immigration and Customs Enforcement (“ICE”) detainee populations have grown by over 300% to ~35,000

State demand drives growth: - State prison populations are projected to increase by more than 90,000 over the next three years. If CXW can capture ~13% of this demand, it could achieve 100% occupancy - “Of the 19 state customers that CCA does business with, we are currently estimating that those states will have an incremental growth that will be twice as much as their funded plan capacity by 2013.” – Damon Hininger, CEO, Q1 Earnings Call

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Supply / Demand Imbalance Drives Growth: - If private prisons can capture just 25% of the incremental growth in the U.S. inmate population, CXW should achieve >98% occupancy in its Owned & Managed business by 2012. Private prison operators captured 49% of the growth in 2007 as state budget pressures have postponed new prison construction

Near-Term Catalysts: Post-Recession Growth: -Inmate populations have historically grown at an accelerated rate after recessions -Of 300,000 prisoners released from 15 states in 1994, 67.5% were rearrested for a new offense within three years

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Near-Term Catalysts: Increased Occupancy Drives EBITDA: - At current margins, CXW management estimates its inventory of existing beds could generate an additional ~$100mm of EBITDA -Available bed inventory increases likelihood of winning contracts and provides pricing leverage Near-Term Catalysts: Operating Leverage - Management derives its ~$100mm estimate by applying CXW’s Q2’09 margin to the lease-up of its existing inventory; however, approximately 84% of the costs in CXW’s Owned & Managed Facilities segment are fixed

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Near-Term Catalysts: Stock Buyback -CXW’s repurchase of 10.7 million shares in Q4 ’08 – Q2 ’09 (~8.5% of total shares) provides a tailwind for NTM free cash flow per share growth

Strong Free Cash Flow Generation: -Because prisons are made of concrete and steel, depreciation expense meaningfully exceeds maintenance capex. As a result, CXW’s free cash flow per share is substantially greater than earnings per share

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Strong Balance Sheet: As of Q2’09, CXW’s interest coverage ratio was 5.4x. Its next debt maturity is not until 2012. Its cash interest expense is less than 6%, and more than 80% of its debt is fixed rate

High Returns on Capital:

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Culture of Equity Ownership:

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Valuation:

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Historical stock chart:

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Opportunity for multiple expansion: CXW’s earning quality has improved since 2007 as its owned and management segment now accounts for more than 90% of Facility EBIDTA

Key attributes:

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Health care REITs are the best comparison:

Sum-of-the-parts valuation: -CXW is composed of two businesses: an operating company (“OpCo”) and a real estate company (“PropCo”)

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An OpCo/PropCo analysis suggest the stock could be worth between $40 and $54 per share

CXW used to be a REIT: -From 1997 through 1999, CXW operated as two separate companies: CCA Prison Realty Trust (a REIT), and Old CCA (the operating company) CCA Prison Realty Trust was a huge success -IPO’d in July 2007 at $21 per share and immediately traded up to $29 - Upon its formation, CCA Prison Realty Trust purchased 9 correctional facilities from Old CCA for $308mm. It then leased the facilities to Old CCA pursuant to long-term, noncancellable triple-net leases with built-in rent escalators - Within five months of its IPO, CCA Prison Realty Trust used the remaining proceeds from its IPO and its revolver to purchase three additional facilities from Old CCA By December-97, CCA Prison Realty Trust’s stock had moved up to the $40s, trading at a ~5% cap rate and a ~4% dividend yield

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-On January 1, 1999, Old CCA and CCA Prison Realty Trust merged to form an even larger REIT, “New Prison Realty.” In order for New Prison Realty to qualify as a REIT, it had to spin off its management business (“OpCo”) New Prison Realty was not a Success -New Prison Realty saddled itself with debt to fund new prison builds -Before the new prisons had been completed and could generate revenue, OpCo’s operating fundamentals began to decline and occupancy fell -OpCo struggled to maintain profitability and rental payments to New Prison Realty soon had to be deferred -As a result, New Prison Realty’s stock price declined precipitously, limiting its ability to raise liquidity. This was further exacerbated by a shareholder lawsuit stemming from the fall in the stock price -By the Summer of 2000, CXW was on the verge of default and had to raise dilutive capital to restructure and avoid bankruptcy Why Did New Prison Realty Fail? New Prison Realty did not fail because it was a REIT, it failed because: -It had too much leverage -It had an overly aggressive development plan -Its tenant, OpCo, was also over-leveraged - CXW has not been a large taxpayer for the last eight years because of substantial NOLs that are now exhausted

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-Since 2000, CXW has increasingly shifted away from a business focused on the management of prisons toward a business focused on the ownership of prisons

Management Gets It: “The other thing I would point out is before we'd even sell stock, that there's a lot of value in these assets. I hear people talking to me about regional malls selling at six cap rates or parking garages selling at five cap rates or 20 times cash flow and you think about -- or highways selling at 50 times cash flow, you think about prisons as infrastructure or some type of real estate asset, I think these could be even sold and harvested in some fashion to avoid selling stock in the future. So there are a number of things that we could do to finance our growth, but just with respect to cash flow and leverage, we could go quite a ways.” – Irving Lingo, Former-CFO of Corrections Corp, Q2’06 Earnings Call

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Conclusions:

-Very shareholder-oriented management team -Did very aggressive buyback at $10.61 in march -Company is rated BB, but Ackman thinks it is definitely investment grade -Very little competition -Passive investment for Ackman (thinks board and management is incentivized in the right way) -Potential pair trade: short Realty Income -Ackman owns 9.5% of the company Q: Are you concerned about occupancy trends, because there does appear to be decriminalization pressure for drug use from Washington? A: 140% on average in Federal prisons, 170% in California. There is a lot of room and I think the political backlash of letting people out early will keep prison populations high. Just filling out the existing overcapacity fills out their available beds.

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Q: When you think about incentives and how that played into the mortgage mess, and now you look at privatized prison, the state wants less people going to prison, whereas the company wants people back in prison. Do you see any issues with these contracts given the company’s incentive to keep people coming back to prison? A: They do their best to rehabilitate prisoners and do the right thing, which is what wins them contracts. They have higher quality of life than Federal prisons, and I think they have their priorities in order. Q: What keeps the government from saying that the ROC is too much and regulating their ROC? What are leases like? A: Leases are typically 3-5 years (called “management contracts”), with inflation-type rates. They win these contracts and earn a high ROC due to their credibility, which results in their large market share. Everyone wins in this scenario. Q: What are barriers to entry? A: It costs a lot of money to build a prison ($60-80,000 bed). It’s very hard to get financing just to build one prison because just one asset is much riskier than a pool. The biggest barrier is having the expertise and credibility, which makes it extremely hard for new entrants. The management business, however, is extremely competitive. Q: Is there a risk of political opposition? A: Biggest risk is that people stop committing crimes, which is a low probability event. There are more likely to be civil liberties groups suing prisons that are at overcapacity, rather than private groups. Q: What’s your current view on MBIA? A: No longer short bond insurers, it takes too much psychological energy. MBIA is a bad business, and it was allowed to leave all it’s bad risks at another company, which seems very wrong. Bond insurance is a bad business and there are a lot of easier ways to make money. Q: David Einhorn told us that he’s moving into gold amidst long-term risks of a major currency collapse. What are your thoughts on this? A: I am not a fan of gold. I think gold is really just greater fool – you need to go around convincing everyone else to buy it. I think the best way to protect against say, a devalued dollar, is to own high quality businesses with pricing power. For example, we own McDonald’s, which is now at a low multiple, and is generally, a currency-hedged, inflation-protected stream of money. Also, Visa could be a good idea, as long as you’re comfortable with the regulation risk.

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Alexander Roepers Atlantic Investment Management: Atlantic’s Approach to Value Investing Alexander Roepers is the Portfolio Manager of Atlantic Investment Management, Inc., which he founded in 1988, a $4.2 billion global Registered Investment Advisor, with offices in New York and Tokyo. Mr. Roepers is a graduate of Harvard Business School. Roepers: 2,042% return in past 16 years, long only, no derivatives Before 1988: -Six years with Thyssen-Bornemisza Group and Dover Corporation, both multi-billion dollar conglomerates -Primarily active in corporate development, i.e. buying and selling of companies -Learned a lot about valuing companies and due diligence, but came to dislike: -Illiquidity, as it takes 9 to 12 months to sell to a private/controlled company -Premiums of 30 to 50% when buying companies Atlantic: -Founded in 1988 in New York

-Premise: deploy highly concentrated, value investment strategy in the public equity markets to get liquidity and eliminate need to pay premiums

-Today: AUM $1.5 billion, offices in New York and Tokyo

-Single strategy firm offering 5 funds: long/short U.S.; long/short Europe/Japan; long-only funds for the U.S., Europe and Japan

-Supported by 13 highly experienced equity analysts and 3 traders providing 24 hour coverage. Non-investment functions managed by COO/CFO Concentrated Investment: -Simple concept: -Define your universe and know your companies -Do not use leverage -Supposed one has 20 compelling value investment ideas Continue due diligence to select 5 or 6 highest conviction names --Concentrate capital on those as they should outperform the other 14 to 15 names Focus on core competency: -Deep knowledge and experience in universe should yield superior capital appreciation

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Rules of the road when concentrating investments: -Universe definition is key -Invest in transparent companies that can be understood and analyzed -Don’t use leverage -Only invest in companies with solid balance sheets Track record:

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Stock Selection Process: 1. Investment Universe 2. Investment Criteria 3. Buy/Sell Discipline 1. Investment Universe:

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2. Investment criteria: Investment-grade balance sheet -Interest expense less than 25% of gross cashflows (EBITDA)

Avoid commodity pricing dependent firms

-Always profitable companies through economic cycles

-Avoid deep cyclical firms

Recurring and predictable revenues and cashflows

-Function of nature of business, diversity of customer, products and regions served

-Prefer consumable and maintenance/repair/overhaul (MRO) businesses over capital spending-related businesses

Low insider ownership

-Need vulnerability to takeover bids

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3. Buy/Sell Discipline

-Likes to own between 2-7% of shares of the company (2% gives you top 10 status, with which you can knock on the door), but do not want to become illiquid (over 7%) because wants to be able to get out within 30 days without affecting price

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Constructive Shareholder Engagement: Objectives: -Create unique due diligence opportunities at the CEO/CFO level as well as the operational level through constructive engagement -Enhance and accelerate the process of shareholder value creation -Maintain liquidity as well as ability to continue dialogue with top management (ie avoid proxy battles and Board seats) Process: -Build strong rapport with CEO/CFO through multiple on-site and face-to-face meetings -Craft and discuss win-win proposals for management and shareholders, including corporate development, corporate governance, operational restructurings and use of free cash

-Submit these proposals in writing to CEO and, as needed, to the Board of Directors

-As appropriate, broaden discussion of proposals to include other large shareholders, financial media and private equity groups

-As needed, apply public pressure through press articles and regulatory/public filings

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Case study: JM Smucker (SJM)

In Atlantic’s Investment Universe? Yes Liquidity? Yes

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Business description • $4.6 billion leading producer of branded packaged foods

• Acquired Folgers from P&G in late 2008, doubling sales

• 75% of sales from products with #1 share positions

• 90% of sales from U.S. customers Thesis • Defensive business: Consumer staples; trend to more meals and coffee brewed at home

• Well positioned among food peers: Little exposure to food service customers; iconic market leading brands

• Margins expanding: Falling commodity prices; realizing synergies from Folgers deal

• Strong cashflows: Rapid debt repayment; solid 2.5% dividend yield; room for M&A

• Reported EPS, understate cash EPS: $0.40 of non-cash amortization from Folgers deal

• Folgers acquisition: Greater power with distributors and retail trade; larger market cap makes SJM a potential holding for more institutional investors

• Valuation multiple expansion: from current 8.9x EV/EBIT (on next year’s estimates) to 12x, which has occurred repeatedly over the past 15 years

• Low insider control: Vulnerable to unsolicited takeover attempts Sales and earning have grown steadily both organically and through acquisitions:

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Despite recent share price recovery, valuation remains compelling:

-Has been part of Atlantic’s universe of investment candidates for over 15 years

-Visited their headquarters several times in past years, analyzed repeatedly, attended company presentations, but did not invest until early 2009 when its valuation fell below 8x EV/EBIT

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Atlantic’s Other Observations: -Up 30% this year, but strategy has been hard because real move has been in cyclical recovery plays Tremendous rally in commodities and banking as well, which hurt their shorts -Current portfolio is trading at 8x EV/EBIT for 2010 -In 1999, tech bubble sucked all money away from value stocks We see that again here with money running towards cyclical recovery plans and forgetting other companies -ACS (Affiliated Computer Services) in Dallas is an example of this -$7 billion in sales -Potential acquisition target -Share price absolutely flat March – August -ACS is growing earnings year after year, and 85% of next year’s sales are all ready guaranteed -6% top-line growth through recession -In Japan, in Secom, home security company with 25% margins and 97% renewal rates -Should be trading at 12-14x EBIT -Only trading at 9x -Down 5 times year to date -Yamato Holdings (Japanese shipper) is highly attractive as well In Europe, like UK company G4S -Security force deployed around the world (hotels in India, nuclear labs, US-Mexico boarder, embassies, etc) -Very large, stable, growing business -Trading at P/E of 11 Q: Is Smucker a takeover candidate? A: It certainly could be. It’s not very controlled by insiders, but there is a long history and the Smucker family is still very involved. There is a lot of tradition, but there is nothing stopping someone from giving a big cash bid. Q: If the rally keeps going how will this affect your buy/sell discipline?

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A: We haven’t changed our buy/sell discipline in 20 years. Should the market decide to value stocks like ours properly, as it does from time to some, we’ll sell into it and sit on 40% cash for a while. We’ll scale out and sell our positions once they cross our EBIT and P/E/ levels and analyze other companies as we wait for the next big thing. We are not market timers and we are not going to pay up and chase things. For example, in June we got out of many names, some of them too early, but it’s not our job to hold companies at these levels. We are extremely disciplined with our methods. Q: What are your thoughts on Kraft? A: Kraft is way too big for us to analyze. I think they would overpay for Cadbury by quite a bit. Kraft is relatively inexpensive, but I imagine if they buy Cadbury at 14x EBIT, there will be eventual earnings dilution. Q: What is your criteria for shorts? A: Short is 10-50% of gross exposure. 1 or 2% positions, no ETFs. Find names in the space where we look for longs, and find those stocks with more leverage, fundamental issues, etc. Especially now, there are many cyclical recovery plays that are overvalued. Typical holding period – 2 weeks to 2 months. Want to stay a little more net contained with high VIX. Q: Do you have any thoughts on home security firms such as Brinks? A: We’ve been in Brinks before. We might like it again, but it’s market cap is small, so it could be illiquid for us. We want it to get a little cheaper, around $23 or $24. Q: How concerned are you about private label competition for Smucker? How large are the price gaps between the two? What do you think Smucker’s organic growth rate is? A: Wal-mart and these other stores need Smucker brands to build traffic. Food scares always push people towards branded products. These brands have been there for over 100 years, people rely on them and know the quality. Overall, this differs by region and distributor, as do price differences. The organic growth has been GDP +1 or 2%. In recessions, it quite often does better as people change their behavior and eat at home more. Q: What themes are you pursuing over the next 12-18 months? A: We mainly focus on valuations. We could get into cyclical companies, but only if these current valuations come way down. If you look at the 2000 tech bubble, people hitting it now on cyclical recoveries will raise a lot of money, but by next March, 2010 economic data points should show that these 2011 expectations are too high.

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Julian Robertson – Q & A Julian Robertson founded Tiger Management in 1980. Known as the “Wizard of Wall Street”, he is credited with turning $8 million of start-up capital into over $23 billion by 1998. In 2000 the fund returned its capital to investors, though Mr. Robertson retained Tiger for personal investments. Today he is admired for his continued investing success, his seeding and mentoring a large group of "Tiger Cub" hedge funds, which have also been remarkably successful, and his philanthropic activities revolving around his three foundations, The Robertson Foundation, The Tiger Foundation, and The Blanche and Julian Robertson Family Foundation. Q: What have you been doing over the past few years? A: I’ve been seeding new hedge funds, which has been a lot of fun for me and allowed me to live a different lifestyle. I always worried that my epitaph might be “he died getting a quote on the yen.” In addition to the hedge funds, I’ve really enjoyed meeting a lot of good and worthy charities, which has also been a lot of fun. Q: You were incredibly prescient 2-3 years ago regarding value investing and the US housing market. What is your current macro view? A: My big concern is the fact that we are still spending more than we earn, and like any family, when that goes on too long, there comes a point where you have to pay it back. We’re not even thinking about that; we’re thinking about continuing to borrow, and the only people that can lend us that kind of money are the Chinese. I wonder if they will continue to lend to us, as there are a lot of other things they can do with their money, which in my opinion, would be better investments. They may eventually come to that conclusion as well. Q: Do you have an opinion on peak oil? A: On peak oil, I’m kind of bullish on oil stocks, but I am tremendously impressed with the environmentalists who’ve showed me what is happening with solar power. Just this summer, for instance, a golf club where I play, had an entire fleet of solar powered golf carts. As I investigated, I found out that there were cost savings as well as environmental good. I think that solar power will get stronger and stronger, wind will get bigger and better, and as soon as our grid is fitted out in good fashion, I think this will be big enough to improve the environment and hurt the price of oil. Q: During your career you took some time off from investing. The story is that you took that time to reflect. What did you do during those 2 years and how did that change your life? A: It was between the time that I worked at Kitter Peabody and the time that I started Tiger. I went to New Zealand ostensibly to write the great American novel, and I ended up as a house-husband down there. I think every man likes to do something more normally productive, and after a certain period of time, I was ready to come back and start Tiger, which I did in 1980.

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Q: Could you comment on China? Do you think it’s the next bubble in the making or that it is going to pull us out of the recession? A: It very well could be a bubble in the making and I don’t think it’s going to pull us out of the recession. It’s prosperity lies in effect in creating jobs which are used to export goods, which take away jobs elsewhere. I don’t think their consumption patterns will be big enough to offset all of that. Q: What characteristics do you think the Tiger cubs share that contribute to their success? A: I think there are a number of them, and we’ve developed a test over the years that demonstrates some of these qualities. They must be honest, reasonably smart, and very competitive. Those three factors are key to being a really good hedge fund investor. In addition to that, I think that there are so many hedge fund people that are trying to change the world for the better (ex: George Soros, who probably did more to encourage the free enterprise system in Eastern Europe than anybody, among many other great things, Paul Tudor Jones and his help to budding charities, etc) and it’s been a thrill for me to be associated with these people. Q: What do you think about the price of gold? We heard earlier today that it is an attractive asset to hold at this time. Does the price matter? A: I’ve never been a big believer in gold. None of it has ever been used since it was first discovered. There is no such thing as supply or demand in gold, you just state it, and it’s there. You hope that someone who is economically turned towards gold will buy it in higher and higher prices. The price of gold is almost the same today as it was 30 years ago. In my own business, I’ve been the luckiest guy in the world on gold. I was presented a seeding proposition with a guy who specialized and did only gold, and I planned to turn that down, because I don’t really believe in gold. However, I believed in him, and this man, over the last five years, has compounded about 50%, and I don’t know of anybody else who has. I think one of the reasons he’s done so well, is because you have a group that he’s competing with (“the gold bugs”), who are in many instances, certifiably crazy. The next group is someone like me, who gets scared of inflation and wants to get into gold. I’m told you don’t want into get into gold, but get into gold miners, because the price of extracting gold is going down. Q: An earlier speaker noted that we’re borrowing too much money, which will lead to higher interest rates and inflation. How can investors protect against this? A: I think that some sort of negative bond approach is a pretty good way to look at higher inflation. There are a lot of ways to do that. I’ve been buying some things called curve caps, which are for all intensive purposes, puts on 30 year bonds out 5 years. In other words, these are bonds that will be issued in 5 years for a 30 year duration. That’s one of

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the things I am very strong on. I’m sure there are a number of commodities that would fit that bill as well. Q: You made your reputation as a value investor. Can you discuss the essence of your value investing philosophy? A: It’s changed over the years. I originally thought that a value investment was one that was extremely cheap based on assets and earnings. I’ve changed now to feeling that a value investment is one where there is a low price relative to the expected earnings that the company will have over the next several years. You could make a very good case for a lot of companies, for instance, that haven’t always been classified as value stocks. Intel is trading at 16 or 17 times next years earnings – not bad for an company with its sort of intellectual superiority. Google is another one that appears to be over the moon, but is still growing rapidly. Q: Are you diversifying out of the US dollar? If so, how? A: I’m glad you asked that question because it gives me a chance to promote my own book. I think the Norweigan Krona is the way to go, because I think Norway may be the most prosperous, sound country in the world. It has a normal amount of reserves from its oil sales, which are invested well for all of the 4 million people in Norway. I think some other good currencies are New Zealand, in Eastern Europe – the Czech Republic is extremely well run and I think that currency is pretty good. I have a negative view in particular of the British Pound. Q: I think you had some experience at one time investing in the airline industry. What would have to happen for there to be a long-term opportunity in that business to make money. A: I think the airline industry is going to be a decent industry. I think the unions are no longer in a governing position in the airlines, and I believe as that their influence continues to wane, airlines hopes for survival get better and better. A company like RyanAir, which is the lowest cost producer in the world, has been extremely prosperous through this entire decimation of the rest of the industry. Q: What is your future outlook on agricultural commodities? On treasuries? Is there a bubble building up? A: In light of my outlook for the economy and what’s going to happen, interest rates are too low and bonds are too high, but I don’t think that’s really a bubble being created – more of a wrong valuation. Q: Is there any particular country or industry that you are especially bullish on right now? Anything you are especially bearish on?

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A: There are a number of individual companies that I’m bearish on. I think that Mastercard and Visa have a good situation in the credit area, and they’re really not taking much credit risk. I think that the deal now may be to look around and try to find low cost producers like RyanAir and maybe like Intel, which is sort of like an intellectual biggie in terms of technology. Q: When you look back over your career, what are some of the key lessons you’ve learned? A: Never be terribly overconfident. There is always something that can come and swat you in the head. I think the best advice I’ve ever got is that a lot of us sometimes get overly enthusiastic about our business. I did that when I was very young, and my sister came up to me after a cocktail party when I’d expounded on some sort of theory I had at the time, and said that I was becoming a business bore. It was excellent advice and I found that instead of pushing my advice on other people, if I was kind of the quiet guy in the corner of the room, people would come and solicit what I thought. Q: It’s been attributed to you that you believe being invested 200% gross was a less risky than being 100% invested long only? A: I still think that say 120-80 is 40% exposure to the market. I’ve always felt that in this business, if the 50 best (long positions) didn’t outperform what you thought were the 50 worst (short positions), you ought to be in a new business. I’ve been shocked in this business, however, how often the bad outperform the good. Q: Can you talk about saving and government policy? A: I hope the government would change policy and encourage saving rather than spending, which they are doing now. We are totally dependent on the Chinese. Can you imagine 30 years ago someone telling you that for our financial stability we would need the support of China? It’s almost unbelievable. Q: You mentioned the factors that Tiger Cubs have. What characteristics encourage you to seed a new manager? A: Of course, I’d like to see where they’ve been. I do like to see evidence of those characteristics I pointed out, and that’s really what we look primarily for. It’s nice for them to have a particular expertise, and if they’ve worked for some good people along the way.

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Q: How much can you teach yourself and how important is it to work for someone great? A: I think it’s important to do both. I was extremely lucky to have hired some very good competitive, honest, and extremely ambitious young people, who really propelled me along. The learning goes both ways. I think it’s important to get that relationship with the people you work with.

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Sean Dobson Amherst Securities: “Fishing in a Poisoned Pond” – Analytic Methods for Distressed RMBS Investing Sean Dobson is CEO and Chairman of the Board and head trader for Amherst Securities. Widely recognized as one of the leading traders in the RMBS markets, and currently serves on the Executive Committee for MBS and Securitized Products Division of the Securities Industry and Financial Markets Association (SIFMA). Mr. Robson has over 20 years of experience in the mortgage industry, including previous positions with Spires Financial and the MMAR Group, Inc. -Close to 8 million homeowners in USA not paying their mortgages -We view the world in a very specific way, in a certain light. It can be perceived that we have cast the homeowner as a very treacherous opponent for investors. It is the system that’s in place that makes it difficult for investors in mortgages to manage the risk that the homeowner acts in a perfectly efficient way. -The Pre-2005 Definition of Single Family Mortgage: -Secured by Valuable Real Estate -Guaranteed by a Fully Vetted and Credit Worthy Borrower -Senior to Equity Position Commensurate with the Price Risk of the Asset -Originated Under Standards Established by Investor or Guarantor -His firm went around the country in 2005 and saw that single family home loans had moved entirely away from our past expectations (buyer can no longer be expected to sustain payments, no guarantee on fundamental real estate values, your significant equity position in the home would be aligned with the borrower) -By 2006, we were 0/4 on these 4 criteria

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Now: -Terrible Lending Standards – Namely, Limited Documentation Loans to Borrowers with Poor Credit Histories – Account for Bulk of Defaulted Mortgages

-There is no one factor that prescribes a bad loan (all depends on rate, equity, etc) -Average credit score used to be FICO around 700, by 2006, below 700s start to take over market (2/3 of people fail to pay loans)

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-Among securitized loans, new defaults have plunged, in part due to seasonality; liquidations also have dropped recently

-Once new defaults equal liquidations, the inventory overhang stops getting larger every month -Broad averages of recovery outcomes is between $.20 - $.90 on the dollar -Gap between time borrower stops paying and loss is recognized creates period of confusion -In 2007, homeowners are abandoning their loans at rate of 120,000 people/month. -Private label mortgage market is left with 2.2 million loans not being serviced by the borrowers (Fannie MAC estimates 1/3 of these homes are now empty) -November 2008 was realization of losses of 60,000 abandoned loans/month. -The inventory problem continues to worsen rapidly among prime mortgages held by portfolio lenders or insured by GSEs, as new defaults remain high and liquidations low

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-Cure rates have fallen such that once a homeowner misses two payments, a foreclosure is almost inevitable 30 Day Delinquent Cure Rate is under 30% 60 and 90 Day Delinquent Cure Rates are under 5%

-The resolution process is grinding to a halt Real Estate Owned liquidation rates have doubled to 20% per month, while the rate at which non-performing loans are being foreclosed upon has fallen by half to less than 10% per month, resulting in falling REO, but rising inventory

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-The Current “Housing Overhang” is 7 million homes (which doesn’t include any new defaults)

-Affordability is a reasonable predictor of home prices Home prices today are fair to cheap without adjusting for supply demand imbalances

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Where are we today? -Overall median income numbers are actually not that far down, while interest rates are very low Boosted buying power beyond where it was in 2005 and 2006, this should serve as a buffer for the market -Borrower behavior is rational and efficient Believes expecting otherwise is dangerous Example: -90% of borrowers who took out a GSE-insured mortgage in the year 2000 at a 7.5% rate had refinanced within four years 90% efficiency -50% of these borrowers refinanced when the savings were less than $200 per month Deadly efficient Example: -Mortgages originated in California in 2006 went from experiencing $165k of equity relative to the first lien on average in January 2007 to an average Negative Equity of $149k -The Cumulative Default Rate during the same period went from 1% to 48.5%

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-In a recent Harvard Business School report, the authors estimated the implied value of the homeowners’ option to walk away. By refinancing their homes at peak prices, borrowers increased the value of this option by $1.3 trillion in only three years.

-The Cash Flow Process (Before Modifications Became Common):

-More than half of always-performing loans are at high risk of default

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-51% of the performing loans have attributes that have recently experienced a significantly greater rate of default than prepayment

-The worst category of borrowers (limited doc, sub-730 FICO, >120 LTV), accounting for 11.3% of the total, has an annual default rate of 32.7%, while prepayments are 0.8%. If this pattern continues, 98% of these loans will default in only 3 years. -Borrowers who are underwater are much more likely to default and are far less likely to prepay Those borrowers that can prepay generally will and those that cannot will likely exercise the other option – the option to default

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Default rates are brutally high:

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-Another wave of resetting loans is on the horizon. The last wave was driven by subprime loans. This time, it will be option ARMs.

-Re-Performing loans are of very poor quality 61% of borrowers with modified loans are currently underwater Only 11% of borrowers have equity in their homes today, and, at origination, had an LTV below 80% and were fully documented at origination

-29-50% of modified loans have re-defaulted within six months -Re-Performing loans are re-defaulting at a pace of over 11% per month -All modifications are performing poorly, regardless of loan type or credit score

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-Non-Performing Securitized Loans are of terrible quality 79% of all defaulted loans have a current combined LTV above 120% 48% are borrowers with limited documentation loans and negative equity Among defaulted fully documented loans, 60$ are borrowers with below-700 FICO scores and negative equity

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-Non-Performing loans are taking much longer to go through the foreclosure pipeline in 2007, only 4.5% of all defaulted loans were delinquent more than 18 months In 2008, this number rose to 8.8% Today, 17.5%

-Loss Severities (Recovery Rates) have stabilized in all states As the mix of properties getting liquidated changes, average severity will increases The final disposition of the overhang of distressed properties looms

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-When Non-Performing loans are finally liquidated, severities range from 40% on large prime loans to 90% for small subprime loans

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Investment Opportunities: The Search for Double-Digit Returns: Investment Themes they like: I. Loss severities will not increase substantially properly priced Alt-A Senior Securities II. Loses will take longer to realize Subprime mezz and select Subprime Senior Sequentials III. Loan Modifications/Government programs will evolve Various bonds where extension and success of lower coupon loan/principal “cram down” modification boost return even in the face of forward rates

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Highly likely that there will be a re-tooled modification plan, that will hopefully start to solve the major problem of buyers willingness to pay (in addition to their ability to pay). This plan will hopefully reduce the loan plan to something that is less than the losses that the investors would sustain in the foreclosure process (which helps no one). -On some assets, they believe borrow can pay 50-60% of original payment, which while impairing the asset, greatly decreases the risk of default (everyone wins). -A brief word on Commercial Mortgage Backed Securities (CMBS): Parallels Between RMBS and CMBS: RMBS 1. Higher debt to income (DTI) expanded leverage 2. Low documentation begat larger loans and dodgier borrowers 3. Subordinated finance changed borrower behavior 4. Teaser payment created funding mismatch CMBS 1. Lower debt service coverage ratio (DSCR) expanded leverage 2. Pro-forma underwriting begat larger loans and dodgier borrowers 3. Mezzanine and B-Note finance changed borrower behavior 4. Balloon loan and lease terms create funding mismatch Rating agencies set lending standards Ratings-based capital allocation determined “leverageability: Shadow banking system provided the capital Ex: CMBSs paid lower and lower entry yields as the bubble inflated from 2000-2007 as debt entry yield declined

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-The CMBS market in the bubble years was characterized by adverse selection. As the riskiest hospitality/retail loans exploded more than 10x from 2000-2005.

-Net Operating Income for CMBSs is dropping

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-When they mature, most CMBS loans today are simply being extended, with no loss taken (extend and pretend)

-For a typical bubble-era commercial mortgage loan, if NOI drops 20% and the cap rate rises to 8%, LTV jumps to 200% Typical commercial mortgage loan: -NOI = $1 million annually -Cap rate = 4% -Property value - $25 million -At 80% LTV, loan amount = $20 million As cap rate increases from 4% to 8%, the value of the property falls from $25 million to only $10 million, which is half the amount of the loan

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Lloyd Khaner Khaner Capital: Management, Management, Management – The Key to Turnarounds Lloyd Khaner is the General Partner of Khaner Capital, L.P., a long-short hedge fund. Without the use of leverage and after all fees the fund has outperformed the S&P 500 for the following standard comparable periods: one year, three years, five years, ten years, fifteen years and eighteen years. Mr. Khaner earned a Bachelor of Arts, cum laude, from Tufts and holds an M.F.A from NYU. -We think about turnarounds the way real estate people think about successful real estate investing (location, location, location management, management, management) The Key to Turnarounds – 18 years of Outperformance No use of leverage, no illiquid investments, all investments made in regulated public markets, Mr. Khaner has 90% of his net worth in the fund -Up almost 450% in past 18 years -Down 14% in 2008

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-Significant underperformance in 1999, but significant out-performance in bubble crash of 2000 -Focus on turnarounds shows that the portfolio will protect him.

The Key to Turnarounds: Strategy: Value with a Catalyst -Screening out process to avoid value traps First look at debt level, anything about 60-70% debt to equity gets tossed out You can find great value in dying industries, but bad industry often beats out great managers -It takes unique management talent to turn around a troubled company. Finding and investing in this talent is their expertise

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Researching Management and finding companies: “Past is often prologue” -Screens for C-Suite changes -Newspaper/news service reports of management changes -52 week low list -Value investing newsletters -Value investing world in general -Research from anywhere (industry experts, former employees, lexus-nexus, etc) CEO Family Trees:

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Great CEOs train great future CEOs Also look for board seats Extends to finance:

Wait to see where great management goes when they leave companies Turnaround Hall of Fame CEOs:

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Signs of a Successful Turnaround: -Cut unprofitable sales stock gets hit hard (why are you cutting sales?) -Cut headcount -Bring in new senior managers -Communicate with entire company -CEO must visit with every part of the company -Coach employees to a winning spirit, winning attitude -Fix relationships with customers (apologize, deal with them directly) -CEO must present a new plan within 3 months of taking over (most importantly, for Wall Street) -Set high, yet achievable goals (build confidence within the company) -Improve products and/or services -Sales down (slammed by Wall Street, people freak out, but this helps gross margin) -Gross margins up -SG&A down (cutting fat, creating lean and mean organization, you want to see this early on) -Operating expenses down -Inventory levels decline, inventory turns rise (inventory probably bloated so levels have to come down, but you want to see turns going up) -Cut and/or restructure debt and covenants if needed (want to maximize breathing room) -No acquisitions for at least 1 year (first figure out what you are before you figure out what you’re going to be) -Focus on Return on Invested Capital Return on Investment Capital (ROIC): -How effectively and efficiently a company reinvests capital back into its own operations

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The Key to Turnarounds: Turnaround Categories:

Example 1: Molex, Inc. (MOLXA)

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Example 2: Praxair, Inc. (PX)

Example 3: Campbell Soup Co. (CPB)

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Starbucks:

Q: Clearly McDonalds and other regional stores have taken away Starbucks market share. Does your model take into account that these people may not return to Starbucks? A: It’s definitely built in. I believe you’ll see Starbucks taking market share back in 2010. Surveys are all ready starting to show this. Additionally, you really cannot get the same product at McDonalds or Dunkin Donuts than you can at Starbucks. Q: Anthony Mozillo, Ken Lay, etc were all legends. The worst guys are always good salesman. How do you avoid them? A: One simple rule, if I’m going into a meeting and asking the questions, if I walk out of the meeting with more questions than before, I walk away quickly. A background check is very helpful since you can see when a CEO just jacked up a company’s financial through leverage as opposed to actually solid

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David Einhorn Greenlight Capital: Liquor Before Beer, In the Clear David Einhorn is Chairman of Greenlight Capital (a value-oriented investment advisor), believes an investment approach emphasizing intrinsic value will achieve consistent absolute investment returns and safeguard capital regardless of market conditions. Prior to founding Greenlight, he was at DLJ. -Even though you may not always be right in investments, you don’t have to be. Decent portfolio management allows for bad luck and bad decisions (which you can learn from). A bad decision and its lessons: -At May 2005 Ira Sohn Investment Conference, Einhorn recommended MDC Holdings, which quickly shot up, then collapsed with the rest of its sector -5 years later, anyone who listened to David would have lost 40% -Loss was not bad luck, but bad analysis -Downplayed risk of housing bubble fueled by growing debt bubble -Smart investors have been complaining about the housing bubble since at least 2001. -David ignored Stan Druckenmiller’s advice on the bubble Lesson: it isn’t reasonable to be agnostic about the big picture -Considered himself a bottom-up investor, neglected macro viewpoints, which hurt him -Must view overall industries, sometimes move into macro-level insurance -2 basic problems in government 1. Short-term bias (caused by need for immediate popularity, upcoming elections, etc) Internet, modern news cycle, etc, demands short-term solutions -Bernanke and Geithner are examples of short-term decision makers -Paul Volcker made unpopular decisions in the 1980s, but history ultimately shows that these were wise long-term choices 2. Problem of special interests Small minorities get heard through intensive lobbying -Banking lobby is an example of this -Small consequences spread out across individuals across the country -Financial institutions caused the problems, received bailout Once you bail them out, what do you do to discipline the misbehavior? -In the last few months, we see the beginning of another party, which satisfies both need for short-term solutions and banking special interests -These new regulations don’t make anything safer -We’ve now institutionalized too big to fail

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Test ought to be that no institution should ever be of individual importance that if we were faced with its demise, the government would have to intervene Lesson of Lehman: Not that government should have intervened, but that Lehman should have never been that big to begin with -Government dismantled AT&T 25 years ago, which led to great growth and social benefit in the telecommunications industry -Leaders are too influenced by banking special interests -Bailouts have installed a great deal of moral hazard, which in the absence of radical change, every major financial institution will be granting a government backed stock -In effect, we all continue to subsidize the big banks, even though we keep hearing that the worst of the crisis is behind us -Big banks are now developing oligopolies -Mortgage originators are now earning ridiculous profits -Proposed reform does not deal with our current needs -CDS are highly anti-social instrument, because basis packages (bond + CDS) make more money if company fails, so these basis package holders have an incentive to create bankruptcies (GM, Six Flags, etc) -Idea of CDS Clearinghouse just maintains private profits and socialized risks -Trying to make safer CDS is like trying to make safer asbestos -Money markets created systemic risk -During the bubble, companies like GMAC, AIG, GE Capital, etc took enormous, unregulated risks -Rather than deal with simple problems with simple obvious solutions, reform plans are convoluted, only have veneer of reform, serve special interests, and actually reduce transparency -Idea that asset bubbles don’t matter because they can be dealt with after they pop is entirely false -Now told most important thing is to maintain fiscal and monetary support

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-Alternative lesson from 1938 double dip economy: GDP created by massive stimulus is artificial (whenever it is removed, there will be significant economic fallout) We must accept some level of fiscal discipline -Social security and Medicare commitments to retiring baby-boomer generation is astronomical, and federal government does not even count future promises to these retirees -In near term, deficit on cash basis is $1.6 trillion, next years forecast - $1.4 trillion Other studies show US fiscal scenario compares to other countries on verge of default -Fed cannot sell its treasuries without destroying the market -Fed will have to shrink the monetary base if inflation actually shows up -Fed must make sure not to repeat error of holding rates too low too long -Higher rates will become both a fiscal and monetary issue -Fed may need to become a buyer of treasuries of first and last resort -Japan may all ready be past the point of no return since it cannot reduce its ratio of debt/GDP, it can only refinance, but never repay its debt -Japanese debt is financed at 2%, but even with this cheap financing, it cannot repay its debt Imagine effect of market changing Japanese rate to 5% -If market re-prices Japanese debt, Japan could experience default, hyperinflation debt spiral and currency crises -Fiat currencies with structural deficits and large unfunded commitments to agencies are of serious concern -Structural risks are exacerbated by credit rated agencies who overrate sovereign debt of large companies No reason to believe credit agencies will do better on sovereign risk than on corporate risk Greenlight met with Moody’s sovereign agency team, and Greenlight was very disappointed (lack of quantitative models, incredible small team, very short term outlook) Credit ratings only pile on downgrades at the worst possible time, which just makes everything worse

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-Einhorn’s views have changed in the recent crisis How does one know what the dollar is worth given that it can be created out of thin air? -We should continue to buy stocks in great companies, but we must look at gold as well -Gold does well when monetary fiscal policies are poor, and poorly when they are sensible -Gold did great in Great Depression when FDR debased the currency -Ultimately made bottom in 2001 when excitement about future budget surpluses peaked -Gold will do very well in sovereign debt default or currency crisis -Einhorn is tempted to short the dollar, but upon examination of Euro, Yen, and British Pound, everything looks bad Holding gold is better than holding cash (especially now when both are no yield) -Buys options because he can limit losses and create as much leverage as needed -Believes that our solvency is ultimately at risk -Investors need to buy some insurance to protect themselves from some systemic event -As investors, we can’t change the course of events, but we can protect capital in the face of foreseeable risks Q: How can you peg the value of a dollar in this environment? Can you peg the intrinsic value of an ounce of gold? A: Gold is a monetary asset. It is a unique asset because it has no liability associated with it (dollar bills actually say Federal Reserve note actually liabilities of Fed balance sheet). No corresponding liability with an ounce of gold (not subject to leverage, so therefore, highest quality monetary asset). When you look at a dollar, you see a secondary monetary asset. The question isn’t so much what is gold worth relative to a dollar, but what is dollar worth relative to gold. We need to look at gold as a currency of its own. Q: You predicted collapse of Lehman Brothers by looking at its balance sheet, what do you see when you look at the Federal government’s balance sheet? A: Lehman was not an inevitable failure. I didn’t label it as such, I just thought it had a lot of risks and its equity was overvalued. The fact that it went bankrupt had a lot to do with a colossal mismanagement of the situation. The leaders of our country didn’t force Lehman to do the right thing quickly enough. I don’t believe the US is past the point of no return, btu there is a risk that we are heading in that direction unless we do something soon.

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Q: Why are you short GE? A: Not discussing that. Q: Why do you own physical gold versus ETFs or futures? A: Physical gold is cheaper and is actually more liquid than the ETF market, with lower carrying costs. Plus, just fun to visit bars at the vault. Q: Where is the gold located? In the depression era, US government confiscated gold, and the Nixon administration made it illegal to own gold as Americans. A: Gold is located in New York. Q: Could you update your views on the rating agencies? A: The rating agencies are a problem for many reasons. They do a bad job on pretty much everything ranging from municipal to corporate to sovereign debt. Typically, lawsuits against rating agencies are either too vague or dismissed by the First Amendment. Recent ruling stated that the plaintiffs had secure enough reason and potentially viable fraud claim of several billions against rating agencies. The rating agencies may ultimately suffer the fate of the asbestos companies. The regulators should just get rid of credit agencies (too interested in protected shareholders of rating agencies). If shares lost value from this lawsuit, it would help. Major issue with credit agencies is that they are cyclical. They excessively boost companies in good times and excessively harm them in bad times. Q: Are oil or energy stocks a hedge against inflation? A: They are more of a play on the supply and demand of oil or other commodities. There are reasons to worry that the price of oil could go a lot higher (but also worries that it could go a lot lower). Greenlight sometimes invests in energy companies, but this is based on individual valuations, not as a form of solid macro insurance that he spoke about. Q: To what extent is gold all ready pricing in some sort of currency crisis? A: I don’t think that gold is necessarily just about CPI and Inflation. I think there are other forms of inflation (ex: asset inflation). You can look at overall sensibility of fiscal and monetary policies. As they seem to go awry, the price of gold goes up. I think that it makes sense for everybody to have a small fraction of their assets in gold as an insurance just in case something bad happens. Q: What (housing, wages, equity markets, etc) is going to cause inflation?

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A: In 1930s, we had tremendous deflation. Effectively, we defaulted when FDR changed price of gold, and gold performed well. We should not measure a gold investment by inflation vs. deflation, but rather sensible vs. non-sensible policy. Q: How are you executing the trade betting on higher Japanese interest rates? A: Effectively buying call options sold by big banks, 2-5 years out. Volatility is low so premiums are low as Japanese rates have been stable for so long. Q: Do you think there are prospects of higher future taxes? A: There need to be a variety of means to resolve our situation. Taxes can be one of them. There is too much current concern about economic slowdown, which causes us to avoid sacrifices. Q: Japanese have a lot of short-term debt. How does this effect your options? A: There is no way to know exactly what the course will be. What we’ve seen, particularly with AAA rated financial institutions, is that they go from AAA to basically insolvent very very suddenly. The underlying basis for why they were AAA was flawed from the first instance. So, seemingly suddenly, you wake up and find that no one will lend to them. You certainly find that possibility in Japan as well. Q: In inflationary periods, gold is probably the premier asset, but there are other precious metals, as well as real estate and productive economic assets. Have you considered other productive assets as alternatives to gold? A: P/E ratios will collapse with significant inflation (future earnings will have to be discounted back to account for inflation). Real estate is an interesting idea, but the problem is that we all ready have a very over-levered, and probably still very overvalued commercial real estate sector. Q: Have you looked at a pair trade, say short copper/long gold, that could increase the your return? A: We haven’t considered that short of pair trade. I have heard questionable things about the copper market and that the price may be overvalued. The better way to manage risk is through position sizing,

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Eric Sprott Sprott Asset Management – The Financial Crisis Isn’t Over Canada's “Energy Guru”, manages $4.8 billion worth of hedge and mutual funds as CEO and portfolio manager of Sprott Asset Management. After graduating from Canada’s Carleton University and earning his designation as a Chartered Accountant, he entered the investment industry as a research analyst for Merrill Lynch. In 1981, he founded Sprott Securities Inc. (SSI), which became one of Canada’s largest independently owned institutional brokerage firms. In 2000, he divested his entire ownership of SSI to its employees and formed Sprott Asset Management to focus on the investment management business. He is also Chairman of public company Sprott Resources. -Fund run out of Toronto Mining is becoming huge, Toronto is the place to be -Sprott Hedge Fund LP has returned over 450% in the past 10 years.

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Dow now at 10,000. We were at 10,000 at 1999 and we’ve accomplished nothing. This could go down as the lost decade.

A History of Market Forecasts: -Excessive Speculation (March 2000): “In the next few motnhs, if not weeks, we anticipate that the Nasdaq will capiutlate to market liquidity. Valuations are screaming at us! Excessive speculation is running rampant. DON’T BE A PART OF IT!!!” -All That Glitters is Gold (October 2001) “But what will happen to the price of gold if and when it is universally considered as the safe haven of last resort? $400? $500? $700? This is easily conceivable. - Requiem for a Housing Bubble (August 2006) “All manias play out the same way. They are dynamics of greed and fear. The greed of making easy money. The fear of missing the boat.…The housing market was a textbook bubble. It was déjà vu all over again.” “Wealth creation via a housing bubble will ultimately prove to be a sham. In our view, it’s a tautology that a hard landing in housing will mean a hard landing in the economy…and with it, a rough ride for the stock market as well.”

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The Financial System is a Farce (October 2007) “We have long maintained that the magnitude of the credit bubble that has been built up over the past several years continually needs more and more credit and liquidity to sustain itself, else it would implode under its own weight…. Therefore (central banks) will use all means at their disposal to ensure that the bubble lives on for as long as possible, and the means available in this case is the only one they know: to indiscriminately throw money at all problems that surface.” Surreality Check … Dead Men Walking (November 2007) “In spite of recent beatings, the markets continue to believe that (GM’s) stock is worth $27 per share, or a market cap of $15 billion. Yet after the latest write-down in the third quarter, the book value of GM now stands at an eye-popping minus $74 per share. … The stock markets need a surreality check. Connect the dots and the evidence is overwhelming that the equity of many companies is at risk of being wiped out. They are dead men walking.” Looking into the abyss: “Britain was within hours of a banking shutdown last autumn as the government batteld to piece together a rescue plan for the stricken Halifax and Royal Bank of Scotland, it has emerged. Treasury mandarins and Bank of England officials battled the clock to come up with a support package on the weekend of October 12th, 2008. If they had failed, the Financial Services Authority could have ordered the closure of cash machines and prevented deposits at either of the two main casualties of the global financial chaos” -The Observer, September 9th, 2009

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The Bank Balance Sheet:

-Fundamental problem: what is appropriate leverage ratio for banks? -Certainly not 20/1, as Einhorn said, banks must de-leverage -Banks’ assets are only getting riskier (both short term and over the long term) FDIC to the Rescue: ColonialBank, Alabama (Aug 14): -Total Assets: $25 billion -Total Deposits: $20 billion -Cost to FDIC: $2.8 billion (11% write down) Guaranty Bank, Texas (Aug 21): -Total Assets: $13 billion -Total Deposits: $12 billion -Cost to FDIC: $3 billion (25% write down)

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Corus Bank, Chicago (Sep 11): -Total Assets: $27 billion -Total Deposits: $7 billion -Cost to FDIC: $1.7 billion (24% write down) Georgian Bank, Atlanta (Sep 25): -Total Assets: $2 billion -Total Deposits: $2 billion -Cost to FDIC: $892 million (45% write down) Quantatative Easing: -Won’t be found in economics books, new thing, essentially the simple printing of money -From Federal Open Market Committee minutes (Aug 11-12, 2009): “The [Federal Open Market] Committee directs the Desk to purchase agency debt, agency MBS, and longer-term Treasury securities during the intermeeting period with the aim of providing support to private credit markets and economic activity... The Desk is expected to purchase up to $200 billion in housing-related agency debt and up to $1.25 trillion of agency MBS by the end of the year. The Desk is expected to purchase about $300 billion of longer-term Treasury securities by the end of October, gradually slowing the pace of these purchases until they are completed. The Committee anticipates that outright purchases of securities will cause the size of the Federal Reserve’s balance sheet to expand significantly in coming months.”

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-Basically said commercial banks are not buyers of bonds and nobody in their right mind would be a buyer of US bonds -US government raised 200% in the bond market this year than last year Who is buying 200% more? Nobody, the central banks are the buyers of the bonds -This gets to the heart of the potential problem: what happens when quantitative easing finishes? -China is growing, but has done some odd things: -Had a $600 billion stimulus in $4 trillion GDP economy -Exports aren’t improving and have yet to recover -Economy is export driven -Chinese market had tough August when government-owned banks slowed down lending, which brought down the market 25% -Beyond stimulus, we have the same situation in the US (big stimulus, but what happens after?)

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Beyond the stimulus:

- In their 2008 annual report, the Bank for International Settlements (BIS) reviewed previous banking crises and suggested that a sustainable recovery would require the banking system to take losses, dispose of non-performing assets, eliminate excess capacity and rebuild capital bases. The BIS concludes that “these conditions are not being met and any stimulus will therefore only lead to a temporary pick up in growth followed by a protracted stagnation.”

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-We all ready have 2 data points: -Car sales (cash for clunkers ended) -Housing incentive for first time buyers (being abused, expires in November) Data point from homebuilders survey is that foot-traffic fell 15%, building permits down 1.5% -If there is no extension, since 35% of homes have been sold under this program, December home sales will fall by 35% “Revenues in 2009 were almost $420 billion (or 17 percent) below receipts in 2008 and totaled about 15 percent of GDP, the lowest level in over 50 years. At the same time, outlays increased by over $530 billion (or 18 percent) in 2009, to nearly 25 percent of GDP, the highest level in over 50 years. Individual income taxes, the largest source of tax receipts, account for more than half of the total drop in receipts, declining by $230 billion (or 20 percent). Corporate tax receipts declined for the second consecutive year, falling by about $166 billion (or 54 percent).” - Congressional Budget Office Oct. 7, 2009

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HUI Gold Index:

Up 1,133% Greatest stealth bull market of all time While Dow flat-lined for 10 years, you could’ve had over a 1100% return -Sprott Asset Management hit this Various reasons to like gold: -Supply/demand situation (failures to deliver, impure gold) -Sprott sees shortage of gold (more used than produced every year) -Central banks have decided to sell gold for the past 10 years and instead, bought US bonds -Sprott thinks central banks will sell less gold We’re in the stealing business: -We focus on long-term secular trends. “Buy and hold” is not dead if you own the right things -We tend to look for small-mid cap “hidden gems” with a strong chance of significant upside potential, similar to the style of Peter Lynch. -We typically take a big ownership interest -Is it too risky to “swing for the fences?” We don’t believe it is. If market expectations of growth are well below our own growth expectations, we leave ourselves plenty of room for error. -“Prospectivity” is paramount, regardless of “quality” management team.

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Want small to mid-cap stocks, overlooked (little analyst coverage, news coverage), trading at low multiples within the industry Cheapness in the peer group is key -Gold and silver can always be sold (don’t need to worry that there won’t be a market) Investment examples: -Norseman Gold Plc (ASX: NGX): -Market Cap: A$138 mill. / Ownership: 11.1%* -Based in Australia where they operate the country’s longest continually running gold mine -Successful at reducing costs and increasing production after undergoing operational restructuring in late 2008 -Current goal is to increase production to over 100,000 ounces by reaching capacity at their underutilized mill -Further exploration could lead to an upward revision of their production forecast -First 2 long run targets on gold are $2160 and $2450 (from Sprott’s chartist) Multiple at 2000 will be like buying this stock at 0.5x earnings -Every time you hear quantitative easing, you should think gold

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-Corridor Resources Inc. (TSX: CDH) -Market Cap: C$287 mil -Ownership: 19.7% -Based in New Brunswick, Canada -Net production of 20 million cubic feet per day from tight sands play, which could double in the near future as two newly producing wells come on line -Independent report recently estimated the potential for over 50 trillion cubic feet (tcf) of gas is in place amongst its extensive shale properties -If they can prove our reserves of 1 tcf, it should be worth C$1 billion in the market, more than triple the current market cap -Sensio Technologies Inc (TSX-V:SIO): -Market Cap: C$67 mil -Ownership: 13% -Montreal-based company with patented technology that facilitates the broadcast and distribution of 3-D content using existing 2D/HD infrastructure -They can also enable broadcasters to upgrade their HD channels from 1080i to 1080p/60 without using any additional bandwidth not reflected in analysts’ estimates -They provide encoding/compression software for minimal or no cost to 3D movie, television and video games producers -Generate revenue by licenses decoding software to makers of televisions, video game consoles, BluRay/DVD players, set-top boxes, personal computers or other playback devices -Addressable market of at least 1.2 billion units per year with royalty rates ranging from $0.50-$8.00 per unit -Expect typical IP licensing gross margins in the 70-80% range

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Other stocks: Yukon Nevada Gold Corp (TSX:YNG) -Just got license to restart mill, got 600 million to replace mill -Expects $60 million cash flow Excellon Resources Inc. (TSX:EXN) -Lead zinc silver worth $1000/ounce Romarco Minerals Inc (TSX-V:R) -Think they could have 5 to 7 million ounces of ore, potentially 10 million At market cap of 330, that’s still pretty cheap ($33/ounce) History of out-performance:

Q: You commented a few weeks ago that a few major financial institutions were short maybe 600 million ounces of silver. Can you talk about this? A: On the commodity exchange, there’s a report every week that shows if people are long or short silver. The silver short is usually about $6 billion, and about $30 billion of gold is short. These precious metals are moving up. Two banks have about 80% of the short silver position and about 4 represent 60% of gold short(doesn’t know who they are). If it continues to jump up, it’s going to hurt them big time. Q: Can you comment on your position of rare earth metals? A: We’re not in them, even though they’re getting a lot of attention. There are a lot of rare earth metals with all sorts of strange names. Each one has an incredibly small market, so there is hardly anything to invest in, in that area. I have no doubt that they are rare, but it’s not something that I tend to invest in.

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Q: You previously wrote about dead firms walking (Fannie, Freddie, GM, etc). What is your updated version of this list? Who’s walking around dead these days? A: Government. What my concern is, is that people have to buy these government bonds everyday. The research we find says that the central banks are buying the bonds. This can’t go on forever - there will be an auction where we face this problem. When we step back and realize the size of demands on the bond market, and the unwillingness of most people to buy them (why should anyone in Canada buy a US bond with the currency risk?). With social security, unfunded pension payments to federal employees, health care, etc, these government liabilities are unfunded and estimated around $70 trillion. There is no way that the government can deal with these commitments, which are coming due. The piper’s coming. Q: You like to invest in real things. What do you consider real things (aside from gold and other resources)? A: 70% of our long side funds are in gold and silver. About half of which is in physical bullion, the rest in stocks. We believe in peak oil, so we invest in oil and gas stocks as well. We’ll look at anything else, but those make up 85-95% of our holdings. Q: Can you talk about your views on inflation and deflation? A: That is the toughest question these days. I think we’re in a deflationary economy, where left to its own devices, we’d be very deflated. If there is another round of quantitative easing, then the move will be on to real things, and we’ll get inflation of real things. We still may have a deflating economy, but real things will inflate. Q: What are your thoughts on natural gas? On the Canadian economy? A: I don’t spend a lot of time thinking about the Canadian economy. Whatever happens in the US, happens in Canada a day or two later, so I tend to focus on the US. Everyone believes that Canada is in great shape, but we really depend on the US, so bad things in the US hurt Canada. The Canadian budget deficit has exploded. We are creating jobs, but any US issues affect Canada. I think natural gas can go into double digits. Since oil and gas drilling has been cut by 50%, production will fall off (decline rate on natural gas could be 30%). With 30% less gas with no drilling, we can lose 15% of the gas production we now have. I think this is setting the stage for a big move in the natural gas price, and a cold winter would only further boost this.

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-Zeke Ashton Centaur Capital Partners: Stocks the Rally Left Behind Zeke Ashton is the founder and Managing Partner of Centaur Capital Partners, a Dallas-based value-oriented investment firm. He and co-portfolio manager Matthew Richey are the advisors to the Centaur family of private partnerships using a long / short equity strategy, and are the sub-advisors to the Tilson Dividend Fund, a mutual fund utilizing a unique, income-oriented value investing strategy. About Centaur Capital Partners: � Founded in 2002, Centaur Capital Partners (CCP) specializes in value-oriented strategies based on fundamental, bottoms-up securities research and analysis. CCP is based in Southlake, Texas, just outside Dallas. � CCP serves as the investment advisor to the Centaur Value Fund, a long / short, long-biased private investment partnership that was launched in August, 2002. � Centaur Capital is also the sub-advisor to a retail mutual fund, the Tilson Dividend Fund (TILDX), launched in March 2005 in partnership with Whitney Tilson and Glenn Tongue of T2 Partners in New York. � In managing TILDX, CCP utilizes a unique, value-based long-only equity income strategy that seeks to identify undervalued securities and emphasizes income through a combination of dividends and selective use of written covered call options. � Early seed investors in Centaur Capital include Whitney Tilson, John Schwartz, and West Coast Asset Management. � As of September 30, 2009, Centaur Capital had ~ $80M in AUM.

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Stocks that left the rally behind:

Alleghany: Good value, low risk � Alleghany (NYSE:Y) is a unique holding company that operates primarily in the specialty and property & casualty insurance industry. � The company has produced an enviable long-term track record of value creation, by building, acquiring, and selling businesses, and has particular expertise in the insurance, investment management, and natural resource areas. � Alleghany uses a “total return” approach to investing its float, and has a very good investing track record. Over the five years ended 2008, the Alleghany equity portfolio produced an average annualized return of 10.6% versus a -2.2% annualized return for the S&P500. � Despite the terrible double-shot of large gulf hurricanes in 2008 (Ike was the third most costly weather event in the history of the insurance industry) and the destruction on the asset side of the ledger due to declining equity and fixed income prices, Alleghany managed to see its book value per share decline by only 5%. � In mid 2008, Y sold its 55% interest in Darwin Specialty Insurance at 2X BV. � As of mid-2009, the company is sitting on a $4.2 billion investment portfolio, of which about $725 million is at the parent company. Alleghany has a fortress balance sheet, with no debt after redeeming convertible debt in June ’09. � Alleghany reported book value per share at June 30, 2009 of $284.00 per share An overview of the assets at Alleghany: � RSUI is a very profitable underwriter of commercial property insurance and casualty lines including professional liability. RSUI writes over $1 billion in premiums annually, and has produced extraordinary combined ratios the past three years: 80.1% in ’08, 68.9% in ’07, and 70.6% in ’06. The average annual underwriting profit for these three years is ~ $185 million / year.

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� Capitol Transamerica is a specialty P&C underwriter with a focus on the Midwest. The company writes over $200 million per year in premiums with consistent underwriting profits and combined ratios in the high 80s and low 90s. � Employers Direct Corp. writes workers compensation coverage primarily in California. Workers comp in California is not currently priced to allow industry profits, so Alleghany has written down EDC in 2009 and is exiting the business. � Alleghany owns a 33% interest in Homesite, a large homeowners insurance operation. The company paid $120 million for this interest in 2006. Homesite has grown impressively over the last two years. � Alleghany also owns 38% of ORX Energy, an oil and gas exploration company. � Alleghany owns some left-over real estate in Sacramento, about 315 acres. � Alleghany has a $4.2 billion investment portfolio, $725 million at the parent level. The company has a bullet-proof balance sheet, with no debt. The Alleghany Equity Portfolio: - Alleghany’s equity portfolio was valued at approximately $622 million as of June 30th, 2009, or about $70 per share. Shareholder equity was $284.82 per share, so the equity portfolio accounts for roughly 25% of shareholder equity -Approximately 66% of the portfolio is invested in energy. -Top 10 holdings as of June 30th, 2009:

A sum of the parts valuation exercise: � RSUI has $1.1 billion in shareholder equity at Dec ’08, including the investment portfolio. An insurance company that can produce combined ratios in the mid-70s in good years and the high-80s in bad years is clearly worth way more than book value. Assigning a 1.5 X book value multiple to RSUI yields $1.65 billion. � Capitol Transamerica is a pretty good insurance company with ~$300 million of shareholder equity. We value it at 1.15X book value, which is $345 million.

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� EDC is now impaired and has been written down to <$100M in SE. Using a 0.5X book value multiple, I value the remaining assets at $50 million. � Y purchased its 33% stake in Homesite in 2006 for $120 million. Homesite has grown since then, but I don’t have access to full financial statement data. I will conservatively mark it down to $100 million just to be conservative. � Y paid $50 million for its stake in ORX Resources in July 2008 at a time of peak oil and gas prices. We assume this asset might be worth $25 million. � We assign no value to the 315 acres in Sacramento; it’s a small free call option � The cash and investments at the parent company was $725 million as of Q2 ‘09. � Book value at June 30, 2009 was $284.82. Stock price as of Oct 1st was $260, so price / book value was ~ 0.91X. Adding up the pieces:

� Equity portfolio increased in value by ~15% in Q3 (+$100M?) � Fixed income portfolio likely increased in value in Q3 as well (+$100M?) � No major insured catastrophes in Q3; underwriting profit(+$40M?) � Book value at June 30, 2009 was $284.82. We estimate Q3 book value per share will be ~ $20-25 per share higher ($305-310). Why has Alleghany been left behind? � EDC (California workman’s comp) had terrible first half and is likely to be wound down. EDC reported a 1H ’09 loss of $60.7 million due to a combination of reserve strengthening and large reduction in new business volume. This $60.7 million loss effectively masked the fine underwriting profits ($88.9 M) at RSUI & CATA.

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� In Q3, Alleghany sold certain assets of EDC for an undisclosed amount. Going forward, EDC should not be a drag on reported underwriting profits. � Book value at June 30, 2009 was $284.82. This was only a 2.7% increase from the Q1 ’09 figure, during a quarter in which many other P&C insurers reported doubledigit % increases in book value per share. � But Alleghany was not coming off depressed book value figures. BV per share declined by only 5% in 2008 and by only 0.3% in Q1 ’09. WHAT ARE THE RISKS? � As is the case for all P&C insurers, a major catastrophe would ding book value � Perhaps the biggest risk is simply opportunity cost. Alleghany is over-capitalized and very conservatively managed, and they did not take advantage of market weakness in Q4 or Q1 ’09.

Lab Corp. of America: Healthy Profits � Lab Corp (LH) is the #2 player in the U.S. clinical lab business behind Quest Diagnostics (DGX). � LH was founded in 1971, and operates 36 primary regional labs and 1,600 patient service centers. The company processes 440,000 lab tests / day � In 2008, LH had $4.5 billion in revenue and $465 million in net income. Quest reported $7.2 billion in revenue and $581 million in net income. � The U.S. clinical lab industry accounted for approximately $52 billion in sales in 2008. Of this, 55% is accounted for by hospital labs, 34% by independent labs such as LH and DGX, and 11% by physician offices. � Between them, LH and DGX account for approximately 2/3 of the revenue from the independent labs. DGX has ~40% share, while LH has about 25% share. DGX and LH can be thought of as the Coca-Cola / Pepsi of the U.S. lab business. � LH has grown impressively over the last ten years through a combination of acquisitions and organic growth. Revenue grew from $1.7 billion to $4.5 billion over the ten years from 1999-2008. � LH has achieved growth and margin expansion by its early and aggressive push into higher-margin “genomic and esoteric” testing, which are now ~35% of sales. From growth story to cash cow: � LH has been very effective in allocating capital. While revenues grew by 46% over the five year period from 2004-2008, EPS grew by 70% from $2.45 to $4.16. � LH has been an aggressive and consistent purchaser of its own shares. The average diluted share count has fallen from 150.7 million shares in 2004 to 111.8 million at 2008, a reduction of 26%. � LH is likely to continue to buy back shares aggressively. As of June 30, 2009, the share count was down to 108.3 million. LH purchased $95.2 million worth of

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shares between Q2-end and August 10th, and announced a new $250 million authorization in early Q3. � The company generates substantial excess free cash flow. Free cash flow has ranged between 13-15% of revenue over the past seven years. As the company’s growth slows down, cap-ex should decline and FCF should increase. � In mid-2009, LH acquired Monogram Biosciences, a leader in “companion diagnostics” that are used to determine patient selection for existing or newlydeveloped gene-based therapies. Total purchase price is ~ $155M. � The market cap is ~$7.05 billion. Net debt is ~$1.35 billion, so EV is ~$8.4 B. � LH should produce $670 million in FCF for 2009. At the current price of $65, LH A picture of consistency: � The table below shows selected financial metrics for LH over the last eight years. As you can see, this is a terrific business with OCF margins in the high teens and FCF margins in the low to mid teens. � The business kicks off tremendous excess cash, which has been used traditionally for acquisitions and share buybacks. � What kind of a multiple would one normally expect for a business of this quality? � Assuming the market assigned a 15-17X FCF multiple, LH is worth $95-105.

Why has lab corp. been left behind? � Like other health care stocks, DGX and LH have suffered from the uncertainty and political risks associated with “Obamacare.” � These risks aren’t just perceptions. In September, Senator Max Baucus introduced the so-called “Framework for Comprehensive Health Care Reform” in which he proposed the following: 1) a $2.3 billion annual tax on the pharmaceutical sector, allocated by market share; 2) a $4 billion annual tax on medical device

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manufactures, by market share; 3) a $6 billion annual tax on health insurance providers, allocated by market share; and 4) a $750 million annual tax on clinical labs, allocated by market share. � Given the relative market size of clinical lab testing, this tax would have had a wildly disproportionate effect on LH and DGX, which combined had 66% market share amongst independent labs and 33% overall share. LH and DGX together had 2008 profits of $1 billion. On Sept 22, the clinical lab tax provision was killed. WHAT ARE THE RISKS? � Political risk remains the biggest danger to the clinical lab businesses. � Other risks include potential lack of growth opportunities given the significant market potential for competitive price war between LH and DGX MVC: A dollar trading for 55 cents? � MVC is a business development company (BDC) that is oriented toward equity investments in “small and middle market companies with secure market positions, predictable profit margins, and stable free cash flow.” � MVC grew reported NAV / share from $9.40 as of Oct. 30, 2004 to $17.38 per share at Oct 30, 2008 and paid out $1.86 per share in distributions. � The vast majority of the NAV per share growth came from investment operations, NOT from selling shares at a premium to NAV. � Unlike most BDCs, which are essentially high-yield lenders, MVC is equity oriented with a portfolio mix of 65% equity / 35% debt. � As of 9/30/09, MVC reported net assets of $403 million, and NAV per share of $16.59. The recent stock price was about $9, so the current price to NAV is less than 0.55. � The portfolio contained 32 active investments as of July ’09. The top 10 positions accounted for ~ 68% of the portfolio value. � MVC isn’t highly leveraged, with $65 million in debt against a portfolio of cash and investments of $467 million. � MVC pays out a modest The interesting history: � MVC was originally founded in March 2000 by a well-known Silicon Valley VC firm to invest in internet and technology start-ups. � Over the next three years, MVC suffered a decrease in value of $182 million on $206 million in investments (-88%). Luckily the firm had not invested all of the cash raised in the IPO. As of October 2003, there was $124 million in cash and $24 million in VC investments on the books. The company also had tax losses in excess of $150 million that could be used to shield future gains.

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� In September 2003, the MVC board appointed Michael Tokarz to be the Chairman and Portfolio Manager. Tokarz was previously a general partner at KKR, and a 30- year veteran in the private equity industry. � Tokarz signed on for three years for a compensation package consisting of no salary and an incentive fee of 20% of any realized gains. The new board members also voluntarily reduced their salaries by 50%. � With shares selling significantly below NAV, in December 2003 MVC did a tender offer and bought back 23% of the shares at 0.95X NAV. The stock subsequently traded at a much smaller discount to NAV. � Tokarz began investing in “old economy” cash generating businesses, and by yearend 2004 NAV increased by $11.2 million and MVC paid its 1st dividend in Q4. � In December 2004, MVC did another rights offering, raising $60 million at the 0 95X lti l t th h t hi h l l th li ) Centaur Capital Partners 18 same 0.95X multiple to NAV (though at a higher NAV level than a year earlier). Extreme make-over: � In 2006, Tokarz set up an external management firm to run the portfolio, and signed a new management agreement with the more standard 2% of AUM fee as well as 20% incentive fee on realized gains. � The new agreement put a cap on total expenses at no more than 3.25% of AUM for 2007 and 2008 and no more than 3.5% of AUM for 2009 and 2010. � In February 2007, MVC raised $78.4 million at $16.25 per share, a premium to NAV. � MVC reported realized gains in FY 2007 of $66.9 million on the sale of two of the early Tokarz investments, Baltic Motors and BM Auto. � The track record of MVC over the past five years ending October 31, 2008:

Questions about the NAV: � MVC’s valuation committee states the NAV at $16.59 as of September 30th. Can we trust them?

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� MVC does not employ an external valuation service so all valuations are done by the MVC Valuation Committee. Naturally, one should be skeptical when management gets to grade their own tests. � NAV per share actually went UP during the period between June 2008 and March of 2009, a period of time when the Russell 2000 declined by 38%. How is this possible? � MVC provides no transparency into the financials of the underlying investment portfolio companies in terms of revenue, profitability, etc. This isn’t unusual in the BDC universe, but providing better disclosure would likely help MVC’s cause. � Of the $30 million in 2008 operating income, PIK income accounted for $5.5 million, or 18.3% of the total. (PIK, or payment-in-kind, consists of portfolio companies paying a portion of their interest in the form of additional securities or by adding to the principal amount of the current debt instrument. It is non-cash. MVC must include PIK income in its distributable cash flow to shareholders) � BDCs have terrible incentive structures. with management fees and allowable leverage all predicated on reported NAV. This creates Can we trust MVC? � We don’t derive any incremental comfort from independent valuation services. In our view, there are still significant incentive misalignments. Most valuation services only provide the vague assurance that the valuation approach “does not seem unreasonable” and even then only on a cross-section of the portfolio. � It is our understanding that MVC’s valuation philosophy is heavily weighted towards trailing EBITDA, and portfolio company performance on this metric did not decline nearly as much as the R2K. However, some EBITDA erosion can be seen in the NAV decline from $17.29 to $16.59 between March and Sep ’09. � MVC has significant insider ownership, with consistent insider buying and no insider selling. Insiders own ~11%. We don’t consider this definitive, but is supporting evidence of alignment between management and shareholder. � Unlike many other BDCs that have willingly raised significant capital at large discounts to NAV, MVC has not done a dilutive secondary offering and does not appear to be preparing one. � The past behavior of Michael Tokarz and the board in creating a fair fee structure, keeping expenses to a minimum, and delivering significant capital gains well in excess of prior portfolio marks causes us to be favorably inclined towards them. � The current 45% discount to NAV captures a whole lot of bad stuff.

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A peek at the MVC Portfolio: � In looking at the MVC portfolio, the top 10 positions represent the lion’s share of the NAV. While there is little disclosure, we believe that most of the businesses here are established, profitable niche businesses in recession-resistant industries. � Security Holdings was purchased in Sept ’08, and has been written down by 25%.

Why has MVC been left behind? � MVC is very low-key in its communications to investors. The company does no conference calls, doesn’t show up at investing conferences, etc. � MVC competes with other BDCs that have retained investment bankers to raise additional capital. MVC has received little attention from investors or the sell side. � BDCs tend to attract a large retail investor base looking for either yield or sizzle. MVC’s status as a hybrid debt / equity investors leaves it without a buying constituency – its 5% yield compares unfavorably to debt-oriented BDCs, while its lack of any hot theme or specialty leaves it without a marketing angle. � I believe that the NAV trend at MVC caused many investors to question the integrity of the company’s valuation practices. The company offers no transparency and offers no explanations for how NAV could plausibly have increased from June ’08 to March ’09 only to decline from March ’09 to Sept ’09. WHAT ARE THE RISKS? � The integrity of the NAV figure and lack of transparency are the biggest risks to our MVC thesis. � MVC would likely be harmed if the debt markets deteriorated further, as the company will soon need to extend its current lines of credit beyond June 2010.

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Q: Why did you pass on Quest? A: That’s like asking why buy Coke rather than Pepsi. Quest is a little bit pricier, and has more debt. They got behind in esoteric and genomic lab testing, and had to take on this debt to try to catch up. Lab Core is much more efficient in generating FCF per dollar of revenue. Lab Core is just our preference for a number of nuanced reasons. Q: What are the embedded gains in the Alleghany portfolio? A: I don’t know off the top of my head. I would guess that the embedded gains are not tremendously long because from 2000-2002, they sold a number of businesses which got put into cash, which I assume got put into the bond market. Given that in 2008, the bond spreads went so wide on anything that wasn’t treasuries, they may have had some losses, so I don’t think there’s going to be some type of tax trap for you there.

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Jason A. Stock & William C. Waller M3 Funds Banks and Thrifts: Opportunities in a Troubled Sector Jason A. Stock is a founding partner and Portfolio Manager of M3 Funds, LLC. M3 manages an investment partnership that focuses on the US bank and thrift sector. Prior to M3, Mr. Stock was employed by Hovde Capital Advisors in Washington, DC, where he worked with the firm’s series of financial services sector investment funds. William C. Waller is a founding partner and Portfolio Manager of M3 Funds, LLC. M3 manages an investment partnership that focuses on the US bank and thrift sector. Prior to M3, Mr. Waller was employed by Hovde Capital Advisors in Washington, DC, where he worked with the firm’s series of financial services sector investment funds. -Fund invests only in banks and trusts, up 32% last year, including up on the long-side -Focus on small and mid-cap community bank stocks -Community bank is a leveraged play on markets in which it operates -Essential to travel to bank regions, meet with all different banks, real estate agents, bankers, developers Get to know community US Banking Sector: -1,300 publicly traded banks -600 mutual banks -5,500 private banks -7,800 credit unions -Expect this number of companies to consolidate significantly as regulatory structure changes and institutions fail -Of the 1300 publicly traded banks, roughly 93% have market caps below $500 million Generally not followed by Wall Street, have simple balance sheets and easy access to management No competitive advantage with massive banks such as JP Morgan, because they are so hard to understand and you are essentially along for the ride

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US Banking Sector Overview: -Recent capital raises are a positive, but US banking sector remains undercapitalized -Credit quality continues to deteriorate and commercial loan losses are on the horizon -Number of bank failures will continue to increase -Employment outlook remains negative -Defensive banks with excess capital are well positioned to take advantage of the market dislocation Capital in the banking sector: is it enough? -At the beginning of 2009, publicly traded banks and thrifts had $410 billion of common tangible equity. During 2009, $80 billion of common equity was raised, an increase of 20% This number should double for a truly healthy banking system -For every $100 of assets, a bank typically has $85 of loans and $15 of securities. -Tangible common equity levels range between 5 and 7%, and bottomed out at 4.61% in 2008

-Many banks still do not understand what they own, particularly in the form of exotic loans

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Commercial loans: -33% of loans -Banks hold more than half of the $3.4 trillion of commercial real estate debt. Over $1 trillion of these loans are maturing between 2009 and 2013. -Going to be very difficult for a lot of these loans to be refinanced, given that much is underwater at this point

Commercial Real Estate: Loan Extensions -Declining property values combined with increasing CAP rates and vacancies are orcing banks to modify and extend loans. Example: -Loan originated in 2005 -Retail strip center -$10 million appraised value -CAP rate was 6% -$8 million loan (80% loan-to-value) -5 year term with first 3 years interest-only, 25 year amortization -6% interest rate – payment is $40,000 interest only, then $51,544 Banks are faced with a decision: Take losses, foreclose, or just extend the loan and hope the market environment improves

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Example continued: -CAP rates have increased to 9-10% for retail strip centers -The value of the property has decreased by 30% to $7 million -$8 million loan amount is now a 114% loan-too-value -New CRE loans are being underwritten at 60-65% LTV -CRE interest rates are now 8%, payment would increase to $61,745 -Bank is forced to extend the loan for 2-3 years -Renters are negotiating for lower rates, so payments are coming in high enough -Personal guarantees were often not signed, so banks are left with losses -Bank has threat of foreclosure, but would hurt all ready lower property value and force bank to realize loss -So bank is backed into corner, and to not take the loss, is forced to extend the loan, reduce rate from 8 to 6%, and hope that CRE market rebounds Hope is not a good strategy for managing a bank -CRE Real Estate: Credit trends – worse than they appear? Delinquency rate is underestimated because so many loans are being extended

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-Bank failures are still in the early stages All ready 100 this year, expect about 200 next year

-Credit Unions have all ready have 12 failures, given that there are 7800 poorly regulated credit unions, this could be a huge problem over the next few years Banks & Thrifts: Opportuniities in a Troubled Sector: -Characteristics of long opportunities: -Low price-to-tangible book value -Excess capital number one focus, want above 5% common equity -Share repurchase plans -Low loan-to-deposit ratio want banks running at 60-90% loan-to-deposit ratios -Attractive market demographics want university town (good health care system, locally based companies), state capitals (fairly stable base of government jobs), etc -Bearish management team with shareholder focus Have money management list (bank management teams that traffic around bank, fix up bank, and sell it) try to follow these teams -Attractive deposit base banks that have failed so far obviously had significant credit problems, but other common characteristics is low quality deposit base (Internet based CD, chasing funding, etc) Want sleepy bank trading below book value with excess capital that can buy back stock -Risk is now finally starting to get priced into loans

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Example Company: BNCL (Beneficial Mutual Bancorp) -$4.2 billion in asset thrift headquartered in Philadelphia oldest and largest bank in Philadelphia -Excess Capital: 12% common tangible equity-to-assets ratio -High quality $3 billion deposit base with roughly 1.58% cost -89% loan-to-asset ratio has liquidity to make quality loans A lot of value in real estate (own 43 or their 68 branches) Value of this real estate will eventually be passed on to shareholders

BNCL: A Mutual Holding Company What is a mutual holding company? -Unique capital structure that is misunderstood by investors -Less than 50% of the shares are publicly traded. The remainder is owned by the mutual bank -BNCL issued 44% of the shares to the public in 2007 at $10/share Stock is now trading below this level

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Valuation: -Valuation is not what it appears. To the average investor, it appears BNCL is trading over 150% of tangible book value. -However, when accounting for the Mutual Holding Company structure, we estimeate that BNCL is trading at 79% of fully converted book value 2nd Step Conversions: -BNCL sells 56% of shares that are owned by the mutual bank to the public markets in a “2nd step conversion” -The new pool of capital is shared between the current stock holders and the new stock holders, resulting in an increase in tangible book value -The confusion of the MHC structure is now gone, allowing the stock to trade at a fair market valuation Expect it to trade at a premium to tangible to book rather than a discount Why use the MHC structure? -The MHC structure provides management with the capital tools of a public bank, without giving up full control of the bank 1. Buybacks: BNCL began repurchasing shares during the 1st quarter of 2009 Expect continued buybacks 2. Dividends: Public shareholders receive all dividends BNCL does not pay a dividend, but rather buys back shares at a discount to book value 3. Employee stock options: BNCL management has options priced at $11.45/share Allows them to track better management by offering stock options, creates management motivation to increase share price. Management also owns 10% of publicly traded shares. 4. Public companies have a currency for acquisitions M&A Transactions for MHCs: -MHC structure creates many unique M&A opportunities -When buying another MHC, the acquiring MHC only has to pay or the public shares. The acquiring institution gets 100% of the company’s equity but only pays for less than 50%, often getting PAID to buy the bank. -MHCs can only sell to other MHCs -When buying a mutual bank, the acquisition generally does not require any meaningful payment given there are no stockholders or owners

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BNCL: M&A Prospects -BNCL management has an in-depth understanding of the MHC structure and is well positioned to execute a roll-up strategy in their region -600 mutual banks remain of which 90% are < $1 billion in assets -30% of mutual banks are in BNCL’s surrounding states M&A Example: Fox Chase Bancorp (FXCB) -$10.00 -$1.1 billion asset, 11 branch MHC located in the Philadelphia suburbs -Trading at 67% of fully converted book value -Excess capital: 10.6% common tangible equity to assets ratio -Excellent credit quality: non-performing assets are 0.66% of assets -74% loan-to-deposit ratio – has the liquidity to make loans -Management led turnaround & sale of Northeast Pennsylvania Financial -Repurchased 15% of the public shares since going public -Eligible to sell: 3 year birthday is October 2009 Can’t sell to another bank until you’ve been public for 3 years The Math of M&A:

-BNCL pays $15/share for FXCB, a 50% premium to current prices -Given BNCL only needs to pay for 41% of the outstanding shares, the purchase price is $85 million, or $90 million inclusive of merger expenses -In exchange for the $90 million of cash, BNCL receives FCXB’s $125 million of equity, resulting in a net increase in BNCL’s equity of $35 million -Fully converted tangible book value at BNCL increases from $12 to $12.85 Conclusion: -Significant problems lie ahead for banks and thrifts -The large cap bank stocks are priced for perfection -Many attractive investment opportunities exist

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Q: Under this structure, would the M&A take place with stock or cash? A: In this transaction, it would be cash, because Fox Chase has $125 million in equity, and basically shareholders at Fox Chase would be paid with that equity, so cash would be simplest. Often there are combinations, but the key is that after the transaction, the minority shares must be under 50%. Q: Could you speak about the effect that more stringent capital requirements could have? A: Capital requirements in the US banking system need to be changed. Common tangible equity to assets has gotten worse. Given the risky mix of assets, including securities and loans (that now have a lot more risk), we think this ratio needs to be changed. US regulators will likely stick to what we have now, but over the next 3-4 years, there will be regulatory changes that require banks to hold more capital. The problem now is that banks just can’t raise that much capital. Q: What do you like short that’s liquid? A: In short positions, we look for the exact opposite characteristics. Risky securities portfolios that are not fairly valued and are overvalued, banks that do a lot of out of market lending or areas that were bubble areas (ex: North Dallas, Plano markets, etc). Lastly, like really thin capital base where tangible equity to assets is low and they don’t have the capacity to absorb assets. Last time, we presented SNB, which had a thin capital structure and a lot of Florida bubble exposure. They’ve raised a lot of capital and it’s now actually a fairly healthy bank, so we’re no longer short that position. Any bank right now that can raise capital should take advantage of this opportunity when capital markets are willing to give money to nearly any reasonably healthy bank. We think big banks like Wells Fargo should be raising a lot more capital right now. Q: You rely on management reports, but we know that banking is really what management decides to communicate and this has huge variations. How do you know when the numbers are lying to you? What are big danger signals? A: There are a few different resources you can use. With the banking sector, you’re not just relying on SEC fillings, but also call reports with the FDIC. The data is very uniform and is easy to compare banks within the sector. It becomes easy to see disparities. Restructured loans have to be disclosed on a call report, and it’s amazing how many banks have zero on their call report. It’s almost impossible in this market to have no restructured loans, so this is a red flag to us. Securities overvaluations are often overvalued, so you need to know the market prices versus what the bank is stating their value at. There are a lot of banks carrying securities at unreasonable values (build models justifying this so auditors sign off on it). Lastly, you need to explore the community and look at county records and figure out what’s vacant, who owns it, and then questioning banks about these specific loans. We don’t really care about bank earnings as much as creating long-term shareholder value.

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Q: What are your banks saying about deposit competition? How do you assess how relationship-oriented banks develop relationships? Why do you believe there haven’t been more clean start-ups in this environment? A: It’s a very competitive deposit market right now. As long as you keep your deposit under the FDIC limit, you can put it in the next bank to fail and probably get a pretty nice return. Example: Washington Mutual before it failed was paying 5% on CDs while everyone else was paying 2 or 3%. Deposit competition is fierce and there is moral hazard in the system. A lot of heavy construction and land development type banks are seeing deposits basically evaporate, and it’s problematic. Deposits are drying up, which is causing much of this competition. This also causes new start-ups end up having to pay too high of interest rates just to get deposits. They like to see banks that have been around for a while. Q: How long do you see banks continuing to carry underreported losses in commercial real estate? What could the catalyst be for them to realize the losses and sell the properties? A: We don’t know. Regulators are starting to focus more on this. Right now, they are more focused on construction and land development rather than commercial real estate. Regulators are taking things in small steps, making banks take in more capital, recognize these problems in construction and land development, and commercial development will come into focus sometime over the next 24 months.

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Whitney Tilson & Glenn Tongue T2 Partners: More Mortgage Meltdown & A Stock Idea Whitney Tilson is the Founder and a Managing Partner of T2 Partners LLC, which manages three private investment partnerships and the Tilson Mutual Funds. He is Co-Editor-in-Chief of Value Investor Insight. Tilson has been a guest on Lou Dobbs Moneyline and Wall $treet Week, has been profiled by the Wall Street Journal and is a regular columnist for Financial Times. He is the Co-Founder and Chairman of the Value Investing Congress. Glenn Tongue is a Managing Partner of T2 Partners LLC and the Tilson Mutual Funds. Mr. Tongue spent 17 years on Wall Street, most recently as an investment banker at UBS, where he was a Managing Director and Head of Acquisition Finance. Before UBS, Mr. Tongue was at DLJ for 13 years, the last three of which he served as the President of NYSE-listed DLJdirect. Prior to that he was a Managing Director in the Investment Bank at DLJ, where he worked on over 100 transactions aggregating more than $40 billion. -All types of loans are seeing a surge in delinquencies, led by subprime:

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-The wave of resets from subprime loans is mostly behind us:

Monthly resets have greatly declined: Worst loans start to reset 2 years after, so the surge in 07 is coming from 05 lending -Resetting of these horrible loans was the trigger that began bursting the bubbles -So wide that it blew up bear sterns hedge funds, starting in 07 -Surge of resets leads to surge of defaults Subprime is the only category of loans that is not currently getting worse, now stabilized at a very bad place, but not getting worse (mainly because so many of the bad loans have all ready defaulted)

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-Not just a subprime bubble and not just in the housing market Delinquencies of Prime and Alt-A Mortgages Are Soaring:

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- For Subprime: number of homes defaulting and entering the pipeline, is now being matched by number of homes existing the pipeline - Crisis is now being shifted from resets to unemployment, as well as lack of incentive to make payments Delinquencies of Prime Mortgages are Soaring:

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Fannie Mae and Freddie Mac Serious Delinquencies Are Soaring

-US map Spreading from 8 state recession to 40 state recession

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Big Picture: Two Waves of Losses Are Behind Us…But Three Are Looming: Losses Mostly Behind Us -Wave #1: Borrowers committing (or the victim of) fraud, as well as speculators, who defaulted quickly. Timing: beginning in late 2006 (as soon as home prices started to fall) into 2008. Mostly behind us. -Wave #2: Mostly subprime borrowers who defaulted when their mortgages reset due to payment shock. Timing: early 2007 (as twoyear teaser subprime loans written in early 2005 started to reset) to the present. Now tapering off as low interest rates mitigate payment shock. Losses Mostly Ahead of Us -Wave #3: Prime loans (most of which are owned or guaranteed by the GSEs) defaulting due to job loss and home price declines (i.e., underwater homeowners). Timing: started to surge in early 2008 to the present. -Wave #4: Jumbo prime, second lien and HELOCs (most of which are on banks’ books) defaulting due to job loss and home price declines/ underwater homeowners. Timing: started to surge in early 2008 to the present. -Wave #5: Losses among loans outside of the housing sector, the largest of which will be in the $3.5 trillion area of commercial real estate. Timing: started to surge in early 2008 to the present. These are much bigger categories, should we forecast another Armageddon? No, because Waves 1 and 2 were securitized and turned into tradable debt instruments, which had to be marked to market immediately. Banks blow up from these types of sudden losses and don’t have time to adapt. -Why did Bear and Lehman blow up, but not Wells Fargo? Wells Fargo had whole loans, rather than these securitized types. -In terms of systemically important big banks, losses will trickle in over time, and it won’t suddenly shock (and thus crash) the system. -Good news: losses come in over time, so it won’t crash the system -Bad news: losses come in over time (potentially 5 years), which causes drip torture -Bank CEOs won’t be able to predict when these losses will go down (can’t predict unemployment, interest rates, etc), so they won’t be out lending as much. -US Government will not be able to pull support for the system

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-Banking system will stay weak, and will keep our economy weaker than it otherwise would be -It will take time to work through aftermath of greatest bubble in history -Existing home sales have risen in recent months, leading to a decline in inventory, but inventory is still at double historical levels, and shadow inventory lurks:

Home prices look affordable due to price declines and ultra-low interest rates:

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-To qualified borrows, in many parts of the country, housing is affordable and cheaper than renting Home prices were in an unprecedented freefall until a bounce in recent months:

Recent signs of stabilization are likely the mother of all head fakes: Rather than representing a true bottom, recent signs of stabilization are likely due to seven factors that are (or are likely to be) short term: 1. Ultra-low interest rates 2. The $8,000 tax credit for first-time homebuyers 3. More middle (and upper-end) homes are being sold (either voluntarily or via foreclosure), which has the effect of raising the price at which the average home is sold – but more defaults of higher priced homes is very bad news for mortgage holders 4. A decline in resets 5. A reduction in the inventory of foreclosed homes 6. The FHA is providing massive support to ths housing market, in part by doing extremely risky lending Essentially doing subprime lending, which is helping at the moment, but eventually come at a price 7. Home sales and prices are seasonally strong in April-July due to tax refunds and spring selling season

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Another wave of resetting loans is on the horizon. The last wave was driven by subprime loans, this time it will be driven by option ARMs

Banks are selling their REO, but foreclosures have plunged by more than half, ballooning the inventory pipeline.

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Shows banks have stopped foreclosing (down by 50%) and are cleaning out what they do own The best time if you have to sell a home is to sell it in late spring/early summer, so banks used this opportunity to get rid of a lot of their inventory At the same time, they’ve stopped kicking people out, because Obama Administration HAMP is pushing loan modifications These are generally liars’ loans, and most will likely default eventually The current “Housing Overhang” is 7 Million homes – which doesn’t include any new defaults, which are running at approximately 300,000/month! Still growing rapidly

-With such a supply/demand imbalance, housing cannot have bottomed FHA’s loan book is a rapidly growing disaster: -17.9% of loans are in some stage of default -For 2007 loans, it’s 32.4%

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-Estimated cost of $54 billion to bailout FHA Should FHA cut back on lending? How will this affect housing? Existing home sales are highly seasonal:

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Home prices bounced from April-July

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BUT, they always bounce in the spring and early summer!

-We think housing prices will reach fair value/trend line, down 40% from the peak based on the S&P/Case-Shiller national (not 20-city) index, which implies roughly a 10% further decline from where prices were as of the end of Q2 2009 -The key question is whether housing prices will go crashing through the trend line and fall well below fair value. This is a real possibility, though continued massive government subsidies could prevent it. In the long-term, housing prices will likely settle around fair value, but in the short-term prices will be driven both by psychology as well as supply and demand. The recent bounce in home prices has improved psychology, but the supply-demand trends are very unfavorable – There is a huge mismatch between supply and demand, due largely to the tsunami of foreclosures. In addition, the “shadow” inventory of foreclosed homes already exceeds one year and there will be millions more foreclosures over the next few years, creating a large overhang of excess supply that will likely cause prices to overshoot on the downside, as they did in California -Therefore, we expect housing prices to decline at least 40% from the peak, bottoming in mid-2010 -We are also quite certain that wherever prices bottom, there will be no quick rebound – There’s too much inventory to work off quickly, especially in light of the millions of foreclosures over the next few years – We don’t think the economy is likely to provide a tailwind, as we expect tepid economic growth at best for a number of years

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There have been more than 8 million jobs lost so far in this recession, though the monthly rate of losses has eased in recent months:

-As bad as things are, they’re actually much worse. -Just to keep unemployment steady, we have to get back to +150,000 a month, just to absorb immigrants and population growth!

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The unemployment rate continues to rise, reaching 9.8% in September This is higher because a lot of people have given up and not looked for work in the past 4 weeks Chronic Unemployment is Skyrocketing:

The Average Weeks Unemployed is 26.2

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The percentage of unemployed not on temporary layoff has risen to 54%

There are now six unemployed people for every job opening

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5.2% of all jobs have disappeared, far worse than any of the past five recessions:

-Worst unemployment situation since great depression -Consumer confidence is still weak, consumer credit is falling sharply:

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Banks are cutting people off, but people are also cutting spending

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The U.S. Savings Rate Hit a 15-Year High of 6.9 in May, but Fell to 3.0% in August This is good news in the long run, but could be a severe economic headwind in the short run, given that consumer spending is 2/3 of GDP

Household Liabilities as a Percentage of Disposable Income Remains Very High:

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Short idea: Short the homebuilders via the iShares Dow Jones US Home Construction ETF (ITB) Housing Starts, Completions and Sales Are At or Near All-Time Lows:

There Is an Enormous Inventory Glut of New Homes. The Average New Home Has Been on the Market for 12.9 Months:

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Vacant Housing Stock Creates an Enormous Inventory Overhang:

Nearly 6% of Homes Built This Decade Are Vacant:

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Unlike Past Housing Downturns, New Home Sales Have Fallen Far More Than Existing Home Sales:

Debt-to-Equity Ratio of Major Homebuilders:

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Inventory-to-Equity Ratio of Major Homebuilders:

Price-to-Book Ratio of Major Homebuilders:

-No need to build any new homes in the US for years

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Investment Idea #2: Iridium (IRDM) -Believe the valuation is ludicrously cheap Overview: -Iridium is the world’s only communication provider with the ability to provide real-time voice and data communications over 100% of the earth’s services by virtue of the company’s 66-satellite low-earth orbit (LEO) constellation. In addition, Iridium is one of the few satellite operators with the ability to provide effective voice, machine-to-machine (M2M), and high-speed data services. -One of two major players in Global Satellite Communications industry -Single subscriber device works worldwide -Originated by Motorola, who spent $5 billion launching satellites in the late 1990s -Filed for bankruptcy in 1999 with only 50,000 customers due to too much debt and clunky phones that didn’t work inside buildings Niche related service, not for general consumer

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Iridium serves many different markets:

A highly attractive business: -Growing market share in growing industry -Enormous barriers to entry -US Department of Defense is an anchor customer (22% of revenues in Q2 ’09) -Very high and rapidly expanding margins -New products and applications

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-Company does not employ its own sales network Good for growth, as there are many separate groups trying to sell their products Extraordinary growth in subscribers:

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Extraordinary growth in revenue and operational EBITDA:

Subscriber growth driver by commercial and machine-to-machine:

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Yet, the stock has tumbled:

Why is Iridium out of favor? -SPAC strucuture -Many SPAC shareholders were just in it fort he cash payout upon consummation of a deal and are now selling -Many warrant owners are showrting the stock -Iridium tried to mitigate technical issus: -Retired 30.5 million $7 warrants -Issued 16 million new shares -Repurchased 15.9 million shares -Large future funding requirement for Iridum NEXT Next network of satellites is very large ($2.7 billion capex project) -Dismal record of early telecom satellite networks -Prior bankruptcy Iridium came public via a SPAC transaction: -SPACs have very poor track records in general -But Iridium was acquired by a SPAC (Special Purpose Acquisition Company) controlled by Greenhill, a top quality private equity sponsor -The deal price was negotiated during the market meltdown last fall (deal was announced 9/23/08), then the price was reduced in April and warrant dilution was cut back in July

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Iridium NEXT -Current satellite constellation will need to be replaced starting in 2014 -Backwards compatible (existing customers will not need to replace equipment) -Improved capacity and data rates -Total cost: $2.7 billion -Satellites: $1.9 billion – Launch: $0.6 billion – Other: $0.2 billion -Funding: – Internally generated cash flow – Debt – Equity – Revenue offsets (hosted payloads) Iridium’s Cap Ex Requirements Will Rise to Fund Iridium Next, and Then Fall:

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Iridium Should Be Able to Fund Iridium NEXT From Cash Flow, Hosted Payloads and Warrant Conversion:

Valuation:

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Iridium’s Operational EBITDA is Projected to Double in Only Three Years:

We Expect a Mid-20% IRR on This Investment for Many Years to Come

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Drivers of Stock Price Appreciation: • Low current valuation multiple (40% discount to closest public comp, Inmarsat) • Rapid growth in earnings • Removal of legacy SPAC investors • Warrant holders finish hedging (shorting the stock) • Removal of uncertainty overhang related to future capital expenditures Q: Do original depreciation schedules match actual life of satellites? A: Stated life is 15 years. Half of original launched in 1997, the other half a few years before that. They’re still up there working, but based on the new launch schedule we’re looking at a new stated life of 20 years. Q: You talk about millions of people losing their homes; where are they going to live? A: There’s obviously no shortage of homes in America, and there are plenty of vacant homes, so people will just end up renting. The bubble was just essentially too many renters buying homes. Now they will just become renters again.

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Kian Ghazi Hawkshaw Capital Management – Kicking the Tires CFA co-founded Hawkshaw Capital Management in 2002, where he is a Managing Partner and portfolio manager. Hawkshaw is a fundamentals driven long/short investment partnership focused on long-term wealth creation and capital preservation. Hawkshaw seeks investment opportunities in which there is a disconnect between near term market expectations and longer term intrinsic value, and in which it can gain a superior informational understanding of the business through rigorous primary research. Prior to co-founding Hawkshaw, Mr. Ghazi was a senior investment professional at Midtown Capital Partners and the business services analyst at Lehman Brothers. He received his MBA from the Wharton School of Business in 1995, where he was a Palmer scholar. -Fund down only 3% in 2008. -Market seems to be anticipating a V-shaped economic recovery -Stocks are being priced at a full or close-to-full multiple on recovery earnings -We could double dip, have an L, etc, but it is not right to pay full multiples on recovery earnings as we do not know if these will occur Hawkshaw: -Concentrated long/short US equities portfolio -Heavy emphasis on proprietary, investigate research -Trailing 5-year compound annual net return through 9/09: HCM +8.3%, S&P 500 +1% -Short portfolio profitable since inception despite 38% return for S&P How does Hawkshaw invest? -Value investors trying to identify high-quality, one of a kind franchises -Do they provide a well regarded product or service? -Do they have leading or dominant market share? -Do historical returns on capital suggest barriers to entry of competitive advantage? -Who will miss them when they’re gone? -Ensure they are financially strong -Rock solid balance sheet -Positive FCF -Monetizable assets -Kick the tires hard -Know what you own -Turn over stones – uncover the landmines -Ask themselves: What could cause the stock to drop 30% or more and cause us NOT to want to buy substantially more stock?

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Presented LTRE and LSCO at 2006 Value Investor Congress, had 12 month returns of 157% and 106% respectively UTI is their current biggest position, they pitched it at 2008 VIC Now pitching: Core-Mark (CORE) -Core-Mark is the 2nd largest distributor to convenience stores in N. America. Each week it delivers supplies such as food, beverages, and cigarettes to 24,000+ convenience stores.

Bears would say: -Operates in tough, low margin, execution-oriented business -Generates poor returns on capital -Reliant on the durability of the convenience store “box” -Overly dependent on cigarette sales and profits, which are declining -Subject to stronger FDA oversight Variant View: -Core-Mark is a high quality, well capitalized, hard-to-replace franchise -Declining cigarette sales is a manageable issue -Convenience stores are already shifting to high margin fresh food categories to offset declining cigarette sales -This trend is driving a very beneficial revenue and margin mix shift for Core-mark that will offset declining cigarette sales and profits

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-Mix shift could add $20 mm - $25mm of EBIT over next 3 years vs. $37mm of LTM EBIT Our conservative appraisal suggests 50-70% upside potential Why does this opportunity exist? -Underfollowed – only recently picked up by two regional sell side firms -Challenging to analyze – no public comps -Underappreciated margin potential – at an inflection point with margin mix shift Convenience Store Industry Overview:

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Fresh food is the answer:

CORE Company Overview: Distribution can be a good business when: -Route density: provides local economies of scale. Leverage driver and fuel costs and fixed DC investments. -Fragmentation up and down stream: shifts bargaining power to distributor. Limits risk of largest customer bringing distribution in-house. High switching costs: not worth disrupting the supply chain. Results in high customer stickiness and lower churn. -Small drops/Lots of stops. Distributor reduces costs for all customers by aggregating volume.

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There are two national players in the wholesale distribution market servicing c-stores: -CORE has leading share west of the Mississippi, and McLane (owned by Berkshire Hathaway) leads east of the Mississippi. -The major regional competitors, Eby-Brown and HT Hackney, operate predominately in the Midwest and Southeast and have limited overlap with Core-Mark.

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Core-Mark enjoys fragmentation upstream (for the most part): -Cigarettes are nearly 70% of revenue… but only 29% of gross profits. -Phillip Morris represents about half of Core-Mark’s cartons sold, or ~15% of gross profits. -There is no concentration in the non-cigarette side of the business (71% of gross profits).

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Core-Mark enjoys fragmentation downstream. -Approximately 50% of CORE’s customers have less than 10 stores. -Mix of smaller operators and large chains is beneficial as large chains provide route density and independents provide higher margins. -Largest customer is 7.5% of revenue. -Covered by four separate multi-year contracts by region. Switching distributors is painful… -Core-Mark’s deliveries are the lifeline of the c-store. -Fill rates and on-time delivery are paramount. -Core-Mark’s fill rate is 98.5% and on-time delivery is 95%. -Not worth disrupting supply chain for modestly lower price if service levels are good Low customer chern of around 3% suggest high customer stickiness Small drops / Lots of stops… -C-store distribution is a pick and pack business. -Entails bringing a relatively small number of items to many different doors/stores, with each stop highly customized. -Core-Mark purchases with scale and delivers in small quantities, adding significant value to the supply chain. -Aggregation of volume by Core-Mark diffuses delivery costs for all customers.

Kicking the tires: -Competition west of the Mississippi River for chain business is limited. -“Core-Mark and McLane are the only two guys west of the Mississippi that can distribute for a chain. Unless you self-distribute it’s just those two guys.” − Operator of 100+ c-stores -Switching is difficult. -“It’s a big deal to switch. A real big deal. A lot isn’t even quantifiable. Several months where stores are learning new people, systems and processes. Could cause more out-of-stocks than usual. Transition would be a big challenge.” − Operator of 300+ c-stores - “It takes significant cost savings or commitments to make a change. A change will cause pain and impact sales in the short-term… it’s a big process.” − Operator of twenty-state c-store chain

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Fresh food initiative: C-store supply chain: C-stores purchase ~50% of items from wholesale distributors, such as CORE. ~30% of deliveries come from national vendors such as Budweiser, Coca-Cola and Frito Lay -The remaining 20% are local deliveries that items such as milk, ice cream, bread and beef jerky. -The average c-store uses 30-40 vendors that make 40-deliveries per week. The current c-store supply chain is highly inefficient, creating a consolidation opportunity.

Core-Mark’s Fresh Food Initiative accomplishes two things: -Core-Mark is consolidating deliveries by distributing items that have historically been delivered locally (i.e. milk from local dairies and bread from local bakeries). -The drive to consolidate deliveries is well received by c-stores because it allows for better pricing and fewer deliveries. -Core-Mark is also adding new fresh food categories such as sandwiches, fresh fruit cups, salads, etc. to help c-stores offset declining cigarette consumption.

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Attractive sales and margin mix shift: -Gross margins on fresh food sales are 15%-25%, relative to 4% for cigarettes. -Opex is high at first because delivery of fresh items requires two drops per week instead of one. -Running a 2nd route is costly while utilization is low. -Core-Mark enters each geography after securing a contract with an anchor chain in order to cover costs of initial foray. -Core-Mark has established 2nd route density in each market it has entered by securing ananchor chain or groups of chains. High incremental margins ensue as new customers are layered on and route utilization improves. A significant amount of capital has already been invested in fresh food distribution Capabilities: -All but 3 of 22 DCs have been upgraded to include cool-docks and expanded refrigeration for handling milk and other fresh items. -~45% of CORE’s trailers (which are mostly owned) have been upgraded to tri-temp. -Expected to reach 75% in the coming years. Vast majority of fresh food investments already incurred (~$25mm). The fresh food opportunity is substantial. -Core-Mark has identified a $1−$1.5bn+ fresh food and delivery consolidation opportunity within its existing customer base. -The Company’s goal is to add $100mm of incremental fresh food revenues per year. -CORE achieved $85mm, $110mm and $90mm in ‘06, ‘07 and ‘08, respectively. Estimate incremental EBIT margins of 5% - 10%, which really moves the needle for a 1% EBIT margin business.

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Move to fresh food could be a market share game-changer. -CORE’s primary competitor, McLane, only began meaningfully investing in its fresh initiative this year. -CORE has a 5 year head start. McLane’s business model is less adaptable to fresh deliveries. -Two deliveries per week enable c-stores to re-stock more frequently and hold less inventory, which meaningfully reduces their working capital requirements. -Once customers consolidate vendor deliveries of milk, bread, etc. through CORE, it will be difficult to reverse the decision.

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-Initially, CORE is marketing its fresh food initiative to existing customers; however, fresh may prove to be the key differentiator when competing against McLane. Kicking the tires. -CORE is the industry leader in fresh. -“Core-Mark’s fresh program is the leader. It’s better than McLane’s and Eby Brown’s…Very, very high quality program.” − Operator of twenty-state c-store chain -Fresh further entrenches CORE with its customers. -“Fresh entrenches us with Core-Mark. It makes it difficult to switch. McLane doesn’t offer an identical program.” − Operator of 100+ c-stores -Customers place a high value on twice a week delivery. “We were ready for twice a week delivery to reduce out of stock and improve gross margin return on inventory management.” − Operator ~200 c-stores Valuation:

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CORE trades at 12x 2009E EPS and 1x tangible book value. -With modest single digit top-line growth and reasonable fresh food initiative assumptions, operating margins (excl. tax rev) can expand from 0.8% to 1.2%. -Conservative appraisal suggests Core-Mark is worth $45 to $50 per share.

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An investor can purchase CORE at approximately the same price Buffett paid for McLane in 2003.

How does it fit with Hawkshaw’s investing framework? Is it a high quality, hard-to-replace, one-of-a-kind franchise? -Core-Mark is a “specialty” distribution business with… -Route density west of the Mississippi. -Fragmentation up and down stream. -Low customer churn. -Increasingly entrenching itself with its customers through its investments in fresh. -High incremental returns on capital should ensue now that… -Fresh investments are largely complete. -2nd route density has been established. -Customers are shifting toward fresh food and away from cigarettes. Is it financially strong? -Modest net debt level ($30 mil); 0.6x net debt-to-LTM EBITDA. -2005-2008 FCF ranging from $25 to $45 mil, despite growth investments. -Currently trading at approximately 1x tangible book value. -Inventory is primarily shelf stable merchandise that is quickly turned (i.e. cigarettes, candy, beef jerky).

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What could send it down 30% that would prevent us from buying more stock? -Phillip Morris/RJR decide to self distribute. -Cigarette declines accelerate meaningfully. -Rising gas prices and shift to fuel-efficient cars permanently reduces traffic to c-stores. -Recent FDA oversight of cigarettes results in major disruption to sales/demand. We view these as unlikely scenarios based on our primary research. “We will survive through them all. They just make life a little more difficult.” - Operator of 1,000+ c-stores Core-Mark is a Margin Mix Shift Story… -Fresh food distribution produces 15-25% gross margins vs. only 4% on cigs. -Fresh investments are mostly complete and anchor clients are in place in all markets, which results in incremental EBIT margins of 8-9% on additional fresh revenues. -Within Core-Mark’s existing customer base there is a $1bn−$1.5bn revenue opportunity for the fresh food initiative (compared with ~$1.7bn non-cig revenue today). -CORE’s execution on 50%−60% of this opportunity could drive $20mm − $25mm of incremental EBIT vs. LTM EBIT of $37mm.

Q: Have you taken into consideration any of their receivables right now? With these being small mom-and-pop type gas stations or convenience stores with limited access to credit, do you see this being an issue? A: It has not been particularly challenging. Regional competitors described to us that they were seeing this issue present itself with new store formation, as it is more difficult for mom-and-pops to get credit to open up new convenience stores. Q: What is Core-Mark’s ROE? What are inventory turns? A: I look at ROC, which has been poor at below 10%. We think they’ll get into the double-digit range as they shift to this fresh investment. Inventory turns are less than 2 weeks. Q: What do you expect about convenience store size numbers over the long term?

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A: C stores will continue to grow, the small shrink is an economic rather than an environment, but the real driver will be ability to executive on fresh to existing customer base, not on convenience store growth. Doesn’t expect large growth or shrinkage. Q: What will happen in inflation/deflation? A: Inflation is good for CORE as they get mark up and generate holding gains and more profits. It is the reverse if prices are going down. A deflationary environment would be challenging for the company. Q: Among their larger customers, what is the risk of self-distribution? A: Biggest customer operates Circle-K. CORE has 4 separate contracts with them. Circle-K does self-manage in Arizona. They would self distribute if they have tremendous route density (ex: have 500 stores in Arizona, so it is more economic to self-distribute). They also self-distribute in Canada where they have similar route density. They don’t have the density in other markets so they don’t self distribute. They are really shifting towards fresh and want to drive gross profits higher. If they can’t get fresh delivery distribution, they’ll do it themselves out of necessity. Circle-K uses both McLean and CORE about evenly, but CORE should hopefully be better and gain more market share through these fresh initiatives. Q: Won’t something like milk will be higher in a convenience store than in a grocery store such as Kroger? How elastic is this? This industry is very competitive won’t people just go to cheaper grocery stores? A: About 2% of convenience store sales are all ready from milk. What CORE wants to do with milk is take it from the local distributor, and consolidate that into their existing truck routes. The fresh aspect that I talk about typically involves newer products, like fresh salads, fruit cups, sandwiches, etc.

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David Nierenberg The D3 Family Funds: D3 War Stories: Practical Lessons About Building and Protecting Shareholder Value by Improving Corporate Governance David Nierenberg is the Founder of the The D3 Family Funds, which manages $350 million in four private investment partnerships. Mr. Nierenberg serves on the Washington State Investment Board, which manages $80 billion of public employee retirement funds. He is a graduate of Yale College and Yale Law School. D3 (David’s Dirty Dogs) Family Funds: -Long-term investors in a concentrated portfolio of undervalued, domestic, micro-cap growth companies -Constructively engage management teams and boards of directors to build shareholder value -5 year lock-up allows for long-term perspective -Average investment is 7 years long -Looking for companies to double EPS within holding period, typically buy 10-15% of equity in these companies, do not take board seats (but can be just as effective) -Practice “constructive engagement” (try to avoid nasty misbehavior of certain activist funds) -Try to act like first year private equity fund -Who is David? -Graduate of Yale College and Yale Law -29 years serving on public, private, not-for-profit boards -Involved in more than 60 CEO, CFO and senior management changes and searches -4 years on Washington State Investment Board -Chair of Millstein Center for Corporate Governance and Performance and Yale University -Chair of several nominating and governance committees Corporate Governance: -Genuinely important stuff, not box checking compliance idiocy Examples of idiocy: -SPN lead director’s son-in-law gets promoted to executive although he lived in separate town and had no past experience -BRKS punished for actions taken to benefit prior CEO -Routine reports by overworked proxy advisory firms or firms pushing an agenda What is “genuinely important stuff”? -Capable and independent board with capable Chairman and committee Chairs who are good enough to be your kids’ trustees -Board focused on key issues and decides them right -Extremely capable, reasonably compensated executives

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Instead people spend time on: -Voting rights, simple majority, proxy access, annual election versus staggered terms, separation of chairman and CEO These are important facilitators of governance that should not be missed, but if the people and motivations are wrong, you’ve got a problem What do good Boards and Mgmt teams do? -Set strategic focus, hire the right people, make good capital allocation decisions, proper oversight What to do with founders of companies? -Some are great, some develop “foundaritis” and have boards filled with cronies of the founder -Recent example of founder/CEO/Chairman of Dr. Bob Shillman of Cognex (see Wall Street Journal article “Directors Lose Elections, but Not Seats – Sep 28, 2009) -Choice of leaders is critically important, if you get it wrong, can be very difficult to change things up -BRKS cash flow tanks under founding CEO, Bob Therrien:

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-Nierenberg invests in BRKS in summer 2003 1st Investment: -Board hires outside manager Ed Grady -Focused due diligence on CEO successor Grady -Became significantly satisfied -Stock nearly doubles in six weeks and they sold

2nd Investment: -Ed Grady now CEO, Therrien non-executive Chairman -D3 convinces Board not to re-nominate Therrien -Foundaritis comes back, two board members (long time founder cronies) Emerick and Khoury get special options grant (on day of grant, stock goes down 20%, up 30% the next day timing too perfect) -WSJ writes article on backdating of stock options (on 3 separate occasion, board cronies make special gifts to Mr. Therrien, and eventually to themselves) See WSJ article “The Perfect Payday – March 18th, 2006” -D3 fights this and several months later both Emerick and Khoury are gone -Result: competent, clean Board

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BRKS New Mgmt focused company -Cuts costs, monetizes software business, exists AMHS business, pays off debt, generates and accumulates cash -Under old Mgmt and Board: -Company probably would have died in 2007-2009 recession, as did BRKS direct competitor ASYR -Where could BRKS Go from here? -Cyclical recovery underway -CEO predicts strong profits in CY 2010 -3-4 year potential:

If monetize real estate and redeploy excess cash, could shrink share count and further drive EPS.

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Move.com (NASDAQ: MOVE) Making MOVE Move: -Prior management averted disaster, saving company and Board, BUT: -Excessive Management compensations -5+ years of private aviation reimbursement for CEO and CFO to commute weekly to corporate HQ -Excessive dilution through issuance for stock options -Poor capital allocation -Di-worsification -Acquisitions not assimilated and integrated -Internal venture capital -Little core growth, suboptimal cash flow -Holding the lead, but missing the upside Straw that Broke D3’s back -Mis-investment of 74% of cash in auction rate securities -CFO told D3 the cash was invested in treasuries, he either: 1. Lied, or 2. Didn’t know how is cash was invested -D3 tries to be collaborative, but immediately files 13D “We believe that the Board, therefore, should dismiss both the CEO and the CFO. We believe in personal accountability. To us it really is that simple…” -Board tells them to executive NDA, help look at new potential CEO/CFO candidates -The Board makes good: -Drives cost reduction, ultimately yielding 30mm annual savings -Closes/sells underperforming businesses -Brings in strong CEO/CFO from Ebay/Ask Jeeves Steve Berkowitz brought 36x price appreciation to Ask Jeeves:

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-Thinks there is huge upside -Focus on the core’s explosive growth potential -Deepen customer value added for both realtors and consumers and lengthen consumer relationships -Tear down smoke stacks and integrate businesses -Upgrade management -Additional upside: use cash to shrink large share count?

Potential 3.5x or more

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HPY -Though HPY (processor of credit card and bank card payments for merchants (particularly in service organizations)) has exemplary governance and management, they have had some recent issues including security breaches and forced selling of CEO equity position

David sets target price of $40

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Approximately $1.85 per share after tax HPY 5 Year Potential:

Q: What is the competitive advantage of the credit card processor? It seems like the space is pretty competitive. A: -HPY uses their own internal sales force that they can control (control message, pricing, etc) -Focus on transparency, branded as merchant-friendly processor -Others known for pretty bad practices, HPY has been able to triple their market share -Focus on small to medium enterprises (doesn’t make sense for larger companies to be involved) -Focus on restaurants, hotels, etc (low instances of charge backs) -Have own internal processing platform (pretty much everyone else outsources) -Processing volume is growing Q: Where do you stand on the issue of hedge funds having to disclose short positions? A: Not an issue that he’s hurt his head about, with involvement at Yale Millstein Center, now has to think more about it. One thing that troubles him about Corporate Governance Movement is that sometimes it feels almost faith based, rather than empirically based. People need to think about much broader effects on economy. Believes in the movement, but approaches it as a business person with broader focus.

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Q: Have you ever failed or given up? How can we better improve corporate governance? A: Thinks you learn the more from failure than from success. One of his early forays into activism (when operating by himself), took a hostile run at regional department store chain based in Ohio, did not research law of corporation of the company (hugely different procedures governed by state law, Ohio put laws in to hurt activists, ex: number of supermajority protections). Lead insurrection that took down supermajority defenses, but by the time they won the battle, they had no appetite for the war because they had lost faith in the business model of being a regional department store chain as specialty retailers were evolving. Doing return on time analysis up front is extremely important, and you must inform yourself on the law of incorporation, read through by-laws, etc to see if there may be anything unique or that could hinder you. -Try to look at composition of shareholder ownership and see if pattern of shareholder ownership looks potentially successful with shareholder collaboration. Most important thing we can do is get the people right in the first place. Q: There is SEC talk about making proxy battles easier for shareholders, how do you feel about this? A: Generally in favor of approved proxy access for long-time shareholders. Also in favor of changes to the rules that can prevent Founders from always hanging around. Q: Do you have a test for how much is too much for use of the corporate jet? (Ex: Abercrombie disclosed over $1 million of personal use this year) A: Try to see it as a case by case basis. Particularly with specialty retailers located all over the country like ANF, it makes sense, but we still need full disclosure, independent board member (not golf-buddies using the jet for weekend junkets) reviews Q: Can you talk about risk management and portfolio construction since you have a very concentrated portfolio? A: Having a highly concentrated micro portfolio hurt them last year, try to keep portfolio spread across different industries, any time position goes over 15% or 20%, they trim it and do opportunistic trading around core positions. One of the greatest causes of volatility is being so concentrated and being in micro-caps. With large and visible positions, they are not easy to unwind, and it can be very difficult to find a perfect hedge.

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Candace King Weir & Amerlia F. Weir Paradigm Capital Management Bottom-up Stock Picking: Back in Fashion? Candace King Weir is well-respected in small-cap value investing, with a track record dating back to 1972, when she was one of the first women to open her own institutional research firm. Her success in identifying hidden value for investors led her to form an investment advisory practice in 1984 and incorporate as Paradigm Capital Management, Inc. in 1994. Ms. Weir received her BA from Vassar College. Prior to joining Paradigm Capital Management, Amelia Weir was a portfolio manager with William D. Witter, Inc. and previously worked as an equity research analyst at Bear Stearns & Co, Inc. Ms. Weir earned her undergraduate degree at Harvard College, where she graduated magna cum laude, and received her MBA from The Wharton School at the University of Pennsylvania. In addition to her investment-industry experience, she also has a diverse international background, having served as a microfinance consultant for the United States Agency for International Development (USAID). -It has been our heritage for over 30 years. -We are convinced that it is back in fashion. -We also believe that it is about much more than number crunching. It must be combined with a hands-on approach starting with active dialogues with company management. -Bottom-up stock picking combined with a proactive investment approach within the small-cap arena should maximize returns. Bottom-up Stock Picking: -Invest one name at a time -Agnostic to sectors and weightings -Agnostic to macro trends Proactive Investing: -Understand company management’s motivations, vision, philosophy -Evaluate management’s capabilities, competence, and ability to execute -Engage in regular and frequent dialogues with management Do this religiously every 5 weeks Also talk to management of your watchlist -By definition, valuation disconnects and pricing inefficiencies are more prevalent in the small-cap arena. -These inefficiencies largely result from asymmetrical information flows for under-followed, small-cap companies.

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Small-Cap Outperforms Over Time

This Should Not Be a Surprise: In the small-cap universe: -Managements are more accessible. -Business models more readily understood and transparent. -Companies tend to be domestically based, lessening exposure to risks such as currency and commodity price movements. -Companies are more nimble, with the ability to scale and react more quickly to changing events.

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A Tide Does Lift Not All Boats: Managers -Many managers have participated in the rally and met Rising Lift or exceeded their benchmarks year to date, but that alone does not define a successful manager. -The more rigorous test, in fact, is the incremental outperformance they deliver relative to their benchmark. -Most important, is whether they can sustain that outperformance and translate it into a consistent, replicable, long-term track record. A Rising Tide Does Not Lift All Boats: Stocks -While definition there has been strong rally this year, the field is still littered with decimated stocks. -We believe a disciplined, selective approach is the only way to participate in volatile markets, including the current one. -Proactive investing is the critical differentiator to a successful outcome. -Specialty Retail is but one example. Primary Research Is the Core of the Paradigm Process -Maintain ongoing dialogue with senior management, along with detailed earnings models. -Evaluate the competition and the company’s competitive edge within that space. -Understand the drivers to end-user customer demand as well as the fundamentals of customers themselves. -Stick with core competency: Avoid one-offs, where it’s hard to have peer group and valuation comparables. -Our best money has been made by investing in companies we know well, in sectors we understand. Conclusions -Proactive investing is the cornerstone to a successful bottom-up stock picking process -Know the company: Do not invest if you do not know. -Discipline is key: Investment methodology must be consistent for aberrations and outliers to be apparent. -Opportunities are still considerable despite the rally, as not all companies have participated. Diligence is required but rewards can be significantly beyond the benchmark. -The extraordinary economic turmoil of the past 18 months makes this a unique market for investors that may happen once every one or two decades.

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Pitch: WPSLA (Wet Seal) -Own 9.9% -Investment has not paid off yet, but is a conviction play -Right place in fashion (fast fashion cheap clothes with fashion edge) -2 businesses (Arden B 20% of revenues, Wet Seal 80% of revenues) -Got new CEO Ed Thomas in November 2007 Know him well and trust him -2008 was a lackluster year (economy, internal problems, etc) -Have $150 million in cash, with around 100 million shares $1.50 cash/share -495 Wet Seal stores (real estate play) Malls are making deals This will help retailers with strong balance sheets Valuation: -Very cheap: will earn $0.25-0.30 cents a share -Predict $0.32 next year (conservative with no increase in comps.) -FCF of around 10% Catalysts:

1. Turned around Arden B, which they once considered exiting. Actually turned a positive comp. in September (after -20 levels last year)

2. Wet Seal brought in 2 new merchandise managers Comps. should be very easy starting in Q4 3. Arden B (only 80 stores) has huge upside for potential growth

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Paul Isaac Cadogan Management: Investing as a Pari-Mutuel Proposition Paul Isaac is the Chief Investment Officer of Cadogan Management, a hedge fund of funds firm in New York City. He is also the principal and portfolio manager of Arbiter Partners, a hedge fund. Previously Mr. Isaac was associated with SC Fundamental and Mabon, Nugent & Co. and its successor. He has been running money in a value style for 35 years. -2 new broader themes: -View of market tops has changed -What constitutes value has changed -Early EMF done by horse races positive sum pari-mutuel -Macro is key to value -Prefers relatively safe dividend streams rather than investment grade bonds (unless they are way below par) Pitch: Waste Management (“The Michigan J. Fox of the Large Cap Market”)

-Largest waste collection, transfer, and disposition company in the U.S. -Collects 66 million tons of solid waste annually from nearly 20 million residential, municipal, commercial and -industrial customers in the U.S., Canada and Puerto Rico -273 landfills and 355 transfer stations that process 110 million tons of waste per year

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Valuation:

-Geographically highly diversified -Largely liquid, top line growth lagged nominal GDP -Typically poor earnings, bad news prone -EV of 6x EBITDA, generating return on investment capital of 8% -EV has previously traded at 8x EBITDA -FCF of over 8%, dividend 3.7% Deflation + sharp decline in real economic acitvity could hurt company -EPS have grown 50% from 10-year low -In normal times, construction waste is 20-25% They’ve been hurt and a recovery is not priced in -Recycling prices are at cyclical lows -Pressure on municipal budgets could lead to privatization

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-Capital efficiency will grow as company gets greener Could get subsidies for natural gas trucks Revenues and operating income over the past decade:

Since 1990:

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Conclusion: Good value in problematic market Q: Are there any other large cap sectors you like? A: Distribution-oriented electrical utilities and life insurance Q: Absent multiple expansion, why will Waste Management work? A: Their margins are getting better, and in general, the company is likely to have a volume increase from population, aggregate growth, etc. Additionally, there have been significantly decreased elements of their revenue stream, such as natural gas, the price of recyclables, and construction waste. Q: Do they have any international exposure? A: They have a substantial operation in Canada, but it’s pretty much just a domestic US play Q: What do you think of management? A: There’s been some turnover. Management is mainly focused on improving metrics. They have a lot of good mid-level local people with strong organization knowledge.

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Joel Greenblatt Gotham Capital: Formula Investing with a Value Mindset Joel Greenblatt is managing partner of Gotham Capital, a hedge fund he founded in 1985. He has been a professor at Columbia Business School since 1996 where he teaches Value and Special Situation Investing. Mr. Greenblatt is Chairman of the Success Charter Network, a chain of charter schools in New York City.He is the author of You Can Be A Stock Market Genius and New York Times bestseller The Little Book That Beats the Market (John Wiley & Sons, 2005). He is also the co-Founder and Chief Strategist for Formula Investing LLC (www.formulainvesting.com), an online money management firm. He serves on the Investment Board at Penn and the UJA Federation. He earned his MBA at Wharton. -Greenblatt’s “Magic Formula” and what’s wrong with it: -The Magic Formula: Earnings Yield EBIT/EV = Cheap Return on Capital EBIT/Net Working Capital plus Net Fixed Assets = Good Quality This is wrong because it assumes EBIT is really a proxy for free cash flow, but this is not always the case. One issue is that you could think that last year’s earnings might not be indicative of future income (after all, you’re getting future stream of income). There could be fads, earnings peaks, etc. Additionally, EBIT does not take into account of Depreciation and Amortization, and is not necessarily a proxy for FCF. -Created company and website – Formula Investing, where you can get screens of stocks that meet the Magic Formula. -Formula has a lot of flaws, so must pick things that make sense to us. -List of these stocks shows many companies that might have seen their peak all ready Joel eliminates all stocks on list for mainly qualitative reasons -More than 95% of the people have told Formula Investing to just manage their capital for them It seems too difficult to do on your own

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Back Testing: Magic Formula underperformed the market for 47 months in the past 10 years, including a period of 34 months (2/1/06-12/1/08) -Over last 10 years, Magic Formula would have made 291% vs. -2% for the S&P -5 years: Magic Formula 73.1%, S&P 5.1% -3 years: Magic Formula 16.1%, S&P -15.3% -There can be rough years, as the portfolio is 100% long Magic Formula: -Bad Candidate for Long/Short Arbitrage -“Great Candidate for Continued Long Term Out-performance” Q: The first three years, you had dramatic out-performance. What role does that have in your total performance, since the compounding was very significant? A: We came off of the Internet bubble, when value was in favor. When you look at it in comparison to the S&P over the past few years, we’ve still outperformed. As a value investor, you have to take the bad periods; otherwise if this worked every period, the profits would be arbitraged away by everybody doing it. If you do something that is logical, sensible, systematic, and disciplined, then it tends to work overtime. Q: What is your advice to people starting a career in investing or starting a fund? Do you think they should just follow your formula? A: There are a lot of ways to make and lose money in the market. This is a systematic approach that makes sense. Most people don’t know how to analyze businesses. If you’re a value investor, you figure out what a company is worth, you pay a lot less. 99% of people don’t know how to figure out what a company is worth. I don’t know how to determine what a company is worth for 98% of companies. There are problems with this model, as there are with everything, but I will say that I would’ve liked to have had my money in this over the past ten years.

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Q: Does this system work for foreign stocks? A: It is very hard to get back-tested, reliable data on international stocks as the databases and quality of information are not as good as in the US. I’ve seen data that shows that its worked in every country where people have tried it, and we are working on building an international database to make available. Q: Do you plan on continuing to have a free site available for people who aren’t Formula Investing subscribers? A: Yes. I don’t want people to pick up the book and then mess up. I don’t want to lose people a lot of money, so the free site will continue.