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Investment Analysis Group
November 9, 2010
Eric Ward
Introduction to Value Investing
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What is Value Investing?
What Value Investing IS NOT:
Buying bad companies with low P/Es
Macro
Technical
Speculative
What all Value Investors believe:
A share of stock represents a fractional ownership interest in a company
Intrinsic Value The value of a business is based on its underlying assets andcash flow
The price of a stock, on any given day, is unrelated to its intrinsic value
MARGIN OF SAFETY Only buy stocks that are selling in the market forsubstantially below intrinsic value
A different definition of risk
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What is Value Investing?
Areas where Value Investors differ:
Selecting securities for valuation
Estimating fundamental values
Quality of business
Required Margin of Safety
Portfolio concentration
When to sell
How to research
Beware value pretenders
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Does it Work?
Other prominent value investors include:
Joel Greenblat Gotham Partners
Seth Klarman - Baupost
Whitney Tilson T2 Partners
Bill Ackman Pershing Square
David Einhorn Greenlight Capital
Martin Whitman Third Avenue Fund
Dan Loeb - ThirdPoint
Chris Brown Tweedy, Brown
Bruce Greenwald - FirstEagle
Howard Marks Oaktree Capital
Andreas Halvorsen Viking Global
David Greenspan & John Griffin Blueridge Capital
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Ask Warren Buffet Doddsville
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Searching for Value?
Traditional Longs
Businesses with competitiveadvantages
High returns on capital
Owner-oriented management
Old, predictable industries
Contrarian
Cheap, dirty, ugly
Traditional Shorts
Structural business issues
Over-earning
Impossible expectations
Fraud / Bad accounting
Over-levered
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Special Situations
Mergers
Tender offers
Spinoffs
Buybacks
Distress / Turnarounds
Bankruptcy
Thrift conversions
Complex securities
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Examining an Investment
Understand the business how does the company make money?
Unit economics
Earnings power of current assets
Are their barriers to entry?
Does management behave like owners? How are they incentivized?
Is there something that could happen that would cause the company to lose30%+ in value?
Read:
10k (company and competitors)
Earnings transcripts
Trade publications
News
Anything else worth reading
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Business diligence
Talk to:
Management
Customers
Suppliers
Private competitors
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Is it a good business or a bad business?
Does the company have a competitive advantage?
Economies of scale
Network effects
Customer captivity
Captive resource technology, resources, learning curve
Government regulation
The first two advantages are by far the strongest, and they are most compellingwhen found together
Indicators of the existence of a competitive advantage:
Long-term market share stability
Consistent above average returns on invested capital
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Only companies with a competitive advantage can earn above their cost of capital
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Uncovering Intrinsic Value
How much would it cost to recreate the assets of the business today?
Adjust balance sheet to current values
Earnings Power What cash flows can the company generate with current assets
Look at steady state economics
Earnings = Normalized EBITDA Taxes - Capex
Is there franchise value? Only if barriers to entry exist
If not, growth adds no value
Is there hidden asset value?
Other indicators of value
Stock valuation publicly traded minority interests
Private market transactions
Liquidation values
Asset appraisals
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Case Study: PNK
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12/1/06 3/1/07 6/1/07 9/1/07 12/1/07 3/1/08 6/1/08 9/1/08 12/1/08
Summary Market Valuation
Current Share Price $4.64
FD Shares Outstanding 60.1Equity Value $279
plus: Net Total Debt 792
Enterprise Value $1,071
My 2009 EBITDA Estimate $173
EV / EBITDA 6.2x
Consensus 2009 EBITDA Estimate $194
EV / EBITDA 5.5x
Net Debt / EBITDA 4.6xNet Debt (ex. CIP) / EBITDA
(1)3.6x
(1) Co nstruction in P rogres s a t 9/30/08 was $172 mm.
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Case Study: PNK
PNK owns and operates casino hotels in regional gaming markets includingLouisiana, Indiana, Missouri and Mississippi
In 2008 casino valuations decline 70 90% due to:
Declining operating fundamentals
Leverage / financing concerns
Burst of the gaming M&A asset bubble
PNK experiencing revenue and margin compression
4.6x levered; debt maturities coming due in next 18 months
Potential for covenant violations
Ability to finance growth projects in doubt
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Getting Comfortable with the Business
Although major gaming markets such as Las Vegas and Atlantic City wereexperience double-modest pullbacks
PNK operates in markets with fixed numbers of licenses = no new competition
Best project pipeline of any domestic gaming operator
Strong management team - -handman; CFO formerly ran leveraged finance at Bear Stearns
River City project had fix-cost contracts covering 80% of construction costs
Lots of hidden assets
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How much is it worth Asset Valuation
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Reported Adjusted
9/30/2008 Adjus tm ents 9/30/2008 Note s
Cash & Equivalents $125 0 $125 No adjustment
Accounts Receivables 21 0 21 No adjustment
Inventories 7 0 7 No adjustment
Prepaid expenses and other assets 37 5 42 Increase for the appreciation of ASCA stock ($11.50 book value)
Deferred income taxes 9 0 9 No adjustment
Total Current Assets $199 $204
Restricted cash 8 0 8 No adjustment
Land and land improvements 574 (324) 250 I assume $540mm of land is w orth 40% of its current book value
Buildings, riverboats and improvements 1,057 0 1,057 No adjustmentFurniture, fixtures and equipment 491 0 491 No adjustment
Construction in progress 172 (52) 121 Assume 30% reduction in CIP
less: Accumulated Depreciation (426) 0 (426)
Net PP&E 1,876 1,501
Goodwill 45 (45) 0 I assume Goodwi ll has no value
Intangibles 74 (74) 0 I assume Intangibles have no value
Other ass ets 51 0 51 Includes $100m for value of dormant licenses
Total Assets $2,246 $1,756
Current Liabilities 44 0 44 No adjustment
Total Debt 917 917Other Liabilities 102 0 102
Total Liabilities 1,063 1,063
Shareholders' Equity 1,183 693
Tangible Book Value Per Share $19.70 $11.54
Current Share Price $4.64 $4.64
Discount to Tang. BV (76.4%) (59.8%)
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How much is it worth Earnings Power
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Build your model beginning with unit economics
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Valuation of Existing OperationsEBITDA 2005 2006 2007 2008 2009E 2010E
Properties
$11 $72 $75 $80 $75 $75
Boomtown New Orleans 51 81 54 50 45 45
Belterra Casino Resort 40 37 39 30 30 30
Boomtown Bossier City 20 23 18 15 15 15
Lumière Place-St. Louis 1 2 6 10 40 40
Boomtown Reno 10 7 4 0 (2) (2)
International 8 9 13 13 10 10
Total Property EBITDA $141 $232 $209 $198 $213 $213
Corporate expenses (23) (29) (40) (38) (40) (40)
EBITDA $118 $203 $169 $160 $173 $173
Free Cash Flow Buildup 2005 2006 2007 2008 2009 2010
D&A $56 $69 $81 $118 $115 $115
EBITDA 118 203 169 160 173 173
less: Taxes (3) (25) (11) 1 3 3less: Maintenance Capital Expenditures (30) (30) (30) (30) (30) (30)
less: Changes in Net Working Capital 0 0 0 0 0 0
Free Cash Flow $85 $147 $128 $131 $146 $146
% Yield 8% 14% 12% 12% 14% 14%
Multiple of 2009 FCF 7.5x 8.0x
Implied Value $1,091 $1,164
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How much is it worth Hidden Assets
While all the non-cash flow generating assets had some value, only the insuranceproceeds were likely to produce cash in the near future
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had value
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Valuation of Non-cash Flow Generating Assets
Unused Land Valuation
Purchase Adjusted
Area Acreage Price Discount ValueAtlantic City 22.0 $360.0 60.0% $216.0
Baton Rouge 517.0 22.0 60.0% 13.2
Central City 1.5 8.0 60.0% 4.8
Reno 490.0 NA NA 0.0
Total $234.0
Other Assets
Purchase Adjusted
Price Discount ValueUncollected Insurance Proceeds 97.0 60.0% 58.2
President Casino and License 40.0 50.0% 20.0
Two Idle Louisiana Licences 70.0 25.0% 25.7
Construction in Progress 268.3 25.0% 201.2
Total $305.2
Total Value of Non-cash Flow Generating Assets $539.2
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River City was fully financed, but the others were not
When estimating returns on new investments, look to past projects, and themarket in which the company plans to build
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PNK had the most robust project pipeline of any U.S. gaming company, but the
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Summary of Project PipelineExpected Amount
Completio Expected Spent Estimated Estimated EBITDA Total
Project Date Cost To-Date Return EBITDA Multiple Value
River City Mar 2010 $357.0 $50.0 15.0% $53.6 7.5x $401.6
Sugar Cane Bay 1Q 2011 407.0 0.0 14.0% 57.0 7.5x 427.4
Baton Rouge - Riviere 1Q 2012 250.0 0.0 20.0% 50.0 7.5x 375.0
River City Phase II (100 room hotel) Jul-05 75.0 0.0 15.0% 11.3 7.5x 84.4
Total $1,089.0 $50.0 NM $171.8 NM $1,288.4
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Putting It All Together
Existing operations alone accounted for $3.66 a share in value
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Even after being conservative on earnings, assets, and projects, PNK still looked tobe significantly undervalued
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Valuation Summary
FCF Multiple
7.5x 8.0xExisting Operations $1,091 $1,164
River City Project 402 402
Non-cash Flow Generating Assets 539 539
Total Intrinsic Value $2,032 $2,105
Less: Existing Net Debt $872 $872
Less: River City Debt 357 357
Equity Value $803 $876Intrinsic Value per Share $13.37 $14.58
Current Share Price $4.64 $4.64
Discount to Intrinsic Value 65% 68%
Upside to Current Share Price 188% 214%
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Additional Thoughts
Know not only if something is undervalued, but why it is
-economic rationale driving other investors decisions
Understand the risk / reward of your investments only take bets where it skewsheavily in your favor (e.g. 5:1)
seek to know as muchas you can about the issues that matter most
Develop a circle of competence
Catalysts are nice, but you can buy stocks without them for less
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Conclusion
Philosophy
Refine your philosophy with each investment you examine
What characteristics do you like/dislike. What gives you comfort?
What is my time frame?
How much Margin of Safety do I need to sleep at night?
Process
Fish where the fish live
Be systematic keep a record of what you look at and why to play or pass
Develop mental models to frame economic behavior and investing situations
Read everything
Hone your investigative research skills
Be humble know the extent of your knowledge
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Successful investing requires the right philosophy and process
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Additional Resources
Books: See handout
Value Investors Club (www.valueinvestorsclub.com)
Cultivate mentors and build friendships
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