Alex Bossert's Thoughts on Value Investing

Complete Pabrai Funds Annual Meeting Notes: September 10th 2011 in Chicago

noreply@blogger.com (Alex Bossert) — Tue, 13 Sep 2011 02:37:00 +0000

Note: A recorder wasn't used and therefore the following is a summary of what he said rather than an exact transcript.

Prepared Comments:

$100,000 invested in June of 2000 would be $554,600 today. This is an annualized return of 17.3% since 2000 vs. 1.1% over the same period for the S&P 500.

Assets under management: $580 million

A few past ideas:

International Coal Group:

Purchased in February 2010 at $4.3

Sold April 2011 at $10.30

138% return in slightly over 1 year

Wilber Ross founded the company and sought to replicate his International Coal Group playbook. Mohnish discussed Wilbur Ross's history and why it made sense to figure out what he was doing now.

· Mohnish liked that the company was going into metallurgical coal

· Fairfax was buying

He found the investment from looking at Fairfax fillings

Reverse engineering other people’s ideas is a very powerful approach

Terex:

Purchased in April 2009 at $12.21

Sold April 2011 at $37.3

206% return in 2 years

Mohnish became interested when the stock fell 90%

Thesis: 100+ NYC’s to be built over the next 100 years. Places such as China and India are expanding rapidly.

Healthy balance sheet to ride out the storm

2-3 years out sales and FCF are likely to grow significantly due to fast growth in the Asia markets

Downside protection: selling below replacement cost

Terex was a 2% basket bet

At a price of $16 Terex is interesting to look into again

London Mining:

Purchased at $1.26 in December 2008

Sold July 2011 at $6.3

360% return in two and a half years

Found this idea by looking at John Burbank’s portfolio. They owned over 13% of the company.

The company was trading for $146 million and had cash of $300 million

This idea plays into the 100 cities thesis

Low probability of loss of capital

Management was unknown

Took comfort in the fact that it was a net net and John Burbank’s ownership

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Some large caps are quite cheap today

The fund has a large non US exposure. 55-60% of the portfolio has revenue/ assets outside the United States.

25% of the fund’s cash went into recent volatility. The fund was able to put meaningful capital to work. The fund still has plenty of dry powder.

10% of the portfolio has gone into Japan. This is the cheapest market in the world. Very cheap and consistently profitable. There is a wide discount to intrinsic value and Mohnish expects good returns.

Mohnish’s first ever stock tip:

Taisei Oncho (JASDAQ: 1904)

Founded in 1941

Design and manufacture AC/ plumbing equipment

$59 million market cap

Cash plus bonds minus unearned revenue minus debt is $114 million

Net Income $6.1 million

Pabrai Funds has been buying every share offered since December 2010

Pabrai Funds now owns 1.4% of Taisei at an average price of $4.28

Consistently profitable since 2006

Tangible book value of $16.78

This company is trading at ¼ of intrinsic value

30-40 similar companies in Japan

Question and Answer session:

1. Can you discuss you investments in Goldman and BYD?

He doesn’t discuss particular investments. But he did say that he got the ideas from Buffett.

2. Given Buffett’s investments in Bank Of America, what does he think of the company? Are the warrants more attractive than the common?

He will not comment if he is buying or not. But he cited a study written by a few professors that said if you buy what Buffett has bought at the end of the month that his holdings are announced. And purchased at that week’s high price, you would still do significantly better than the S&P. So Bank of America is probably a good place for investors to look.

3. Mohnish invested in Frontline in 2004. The shipping industry is very distressed right now. Is it worth looking into at this point?

Very large crude carriers (VLCC’s) have a lead time of 3-4 years between when they are ordered and when they are delivered. A large amount of orders were placed at the end of the boom. Because of the long lead times and unintelligent behavior by ship buyers (namely the Greek’s) this market is subject to huge boom and bust cycles. The smaller ships and dry bulk ships have less volatility.

Frontline had most of its ships on spot charters. Then rates collapsed. Across the industry the single hull ships were taken out of service and scrapped.

If Frontline liquidated its VLCC’s, the value of those ships only fell from $70 to $60 million. The stock priced the ships at $15 million.

He bought because the stock was really cheap but it’s a bad industry over time.

4. Why were the investments in 2008 so small?

Some were basket bets on commodities and those were 2% positions. Normal positions are 5%. 10% is the most he will put into a company. The Japan basket bet is currently 10% and could reach up to 20% of the portfolio.

5. How do you value Potash?

He won’t discuss current holdings.

6. When making investments in commodity companies, how do you handicap for the risk of more supply entering the market and low barriers to entry?

It’s important to know where the company is on the cost curve. They want to own the lowest cost producer. When the price of the commodity goes down, the highest priced mines will close but the lowest cost producers will continue to be profitable.

7. If a 5% investment quadruples and goes to 20% of the fund, will you trim that position?

He’s never trimmed a position. The portfolio is less concentrated now, so this is less of an issue. He will only sell if it goes above intrinsic value or he finds a better investment. He usually sells at 90% of intrinsic value.

8. How do you analyze Japanese companies when information might be difficult to get or only in Japanese?

Financial statements are always in English and that’s the first step. It’s a basket bet so he spends less time researching each company than he would for a normal position. He didn’t hire a translator because that would take too long. Japan has a very trustworthy culture. He would never do the basket approach in China, India or most other places.

9. What are some investments that have lost money in the past?

The Pabrai Funds have made mistakes. The frequency of mistakes has gone down. One mistake was Sears. Many smart people were buying. Lampert is a smart guy. But he should have realized that it was a poor business. The business continues to deteriorate over time and the company has no moat. The funds lost 60% on their investment in Sears. He added an item to his checklist to prevent this mistake in the future.

10. Why did he sell Berkshire Hathaway?

Berkshire is doing well and is likely to do better than the index over time. But he can find cheaper things to invest in.

11. Are placeholders still part of the portfolio?

He no longer uses them because they didn’t work. One of his mistakes going into the financial crisis was being fully invested. The placeholders went down a lot which hurt the portfolio. It’s a much better idea to have a cash cushion because it tempers a decline and it provides dry gun powder when stocks get cheap.

12. Why is he invested in alternative energy?

He doesn’t want to discuss his ideas so he wouldn’t answer this question.

13. How do you structure the portfolio to withstand a crisis?

The portfolio has become more diversified and he also holds a larger cash cushion.

Charlie Munger says if you can’t handle a 50% drop in your portfolio then you shouldn’t be investing because that will eventually happen.

Berkshire Hathaway has gone down 50% a few times even though it’s a great business. In a stock market decline the fund will most likely go down.

However, investments such as the one in Japan will not be correlated to the rest of the portfolio.

14. How do you deal with currency in foreign investments?

He said he has no great insight into currency and he didn’t hedge the Yen. Since he started buying Japan, the index is down 15% and the Yen is up 8%. So far his basket is profitable. He ignores the effect of currency.

15. When investing in distressed businesses, how do you distinguish between a temporary verse long term problem?

He admitted making mistakes on this in the past. This is one of the most important factors and he spends a lot of time on this question. But it comes back to finding the intrinsic value and comparing that to the stock price. Investors need to determine if the distress is justified or not. For example, London Mining was worth much more in a private transaction than the price the Pabrai funds were buying at.

16. When you interview corporate management how do you evaluate their decision making process?

Most CEO’s are very poor capital allocators. A good way to judge management is to look at what tangible book value has done over time. He doesn’t interview management or even talk to them because he doesn’t want to be convinced by their sales skills. Management is always optimistic and this could cloud his decision making process. It’s better to evaluate management on your own and look at their past decisions.

17. For commodity based businesses you look at the cost curve to determine a good investment. What metric do you use for other industries?

In a commodity business he wants to own the lowest cost producer. It’s different for each industry. In retailing he looks at gross margins. This shows how well the company is run. In banking it’s the return on assets. It depends on the industry.

18. I didn’t quite catch the whole question but it had to do with his philosophy on following great investors?

This strategy doesn’t always work. But it’s a great search strategy. He’s found it to be very effective. Mohnish follows Klarman, Burbank, Watsa etc.

19. At what point does creating a basket distance you from understanding individual companies?

He’s borrowing the idea from Ben Graham. The situation in Japan is similar to what Graham was doing in the 1940’s and 1950’s in the US. This basket won’t dominate the portfolio, it’s a temporary thing.

20. How do you manage tough times?

People lose sight of basic reality. Most people freak out when their job is lost. It’s important to focus on what’s most important in life and what makes you happy. Keep a balance between work and those things.

How To Generate Good Investment Ideas

noreply@blogger.com (Alex Bossert) — Fri, 15 Jul 2011 05:04:00 +0000

With 15,000 or more public companies in the United States, how should investors go about finding undervalued companies? Finding companies to invest in is not easy considering there are around 10,000 hedge funds and 7,500 mutual funds scouring the stock market. One of the most important components of being a good investor is the search process. One of the most common questions I get is how I find the companies I invest in. Here are the ways I find companies to research:

1. Check what other successful investors are buying. If Warren Buffet, Charlie Munger, Joel Greenblatt or other great investors are buying a certain company then its always the first place I look. The best site to check what great investors are buying is Gurufocus. For funds not mentioned on this web site, checking the 13f fillings on the SEC web site is a great resource. For example, here are Berkshire Hathaway’s equity investments.

2. I’ve generated a few ideas by asking people I think are very smart, what they are investing in. This is one of the quickest and most effective idea generators.

3. Oftentimes successful money managers will discuss what they are investing in in their letters to investors. Here are a few web sites that post hedge fund letters: MarketFolly and Value Investing World. In addition to these, going to the web site of the fund may lead you to its letters. For example, here are Third Avenue’s letters.

4. I frequently scan the 52 week low list. This is a great way to find distressed companies that could be cheap. I use Morningstar’s 52 week low list.

5. I also read through online investment report sharing sites such as Value Investors Club and Sumzero.

6. Another great resource is scanning the Value Line Investment Survey’s list of “Bargain Basement Stocks, ” “Lowest P/E Ratio’s” and “Widest Discounts From Book Value.”

7. Joel Greenblatt’s Magic Formula screen is another source I use to generate ideas.

8. I subscribe to Forbes, Fortune and the WSJ. These publications are all a great sources for ideas.

9. I also set alerts online for specific events such as delistings, earnings misses, spin offs etc.

10. Blogs and message boards are also a place I go to generate ideas. Some of my favorite are: Corner of Berkshire and Fairfax, Greenbackd and Above Average Odds.

11. Here are some web sites I scan for spin Offs and other special situations: The Online Investor, Arbitrage View and Spinoffs. In addition, the SEC web site is useful for finding out about spin offs. Every spin off has to file a form called a 10-12b with the SEC. Searching the SEC web site for these fillings will give you a list of all the recent spin offs.

12. I don’t use stock screens very often but they can be a great starting point: Yahoo’s seems to be the best. Although, the only decent stock screeners I’ve found you’ll need to pay for.

A Conversation With Charlie Munger

noreply@blogger.com (Alex Bossert) — Tue, 05 Jul 2011 17:57:00 +0000

On July 1st Charlie Munger held his final Q&A with Wesco Shareholders and admirers. This is some of the best reading I've come across all year and I recommend all to read it.

Notes From Charlie Mungers Meeting from The Inoculated Investor Blog

A copy of a 6 page parody of the financial crisis that Charlie Munger passed out before the annual meeting

Most Valuable Takeaways From The Berkshire Hathaway Annual Meeting And some Other Useful Reading

noreply@blogger.com (Alex Bossert) — Fri, 13 May 2011 16:50:00 +0000

I attended the Berkshire Hathaway Annual Meeting for the 6th time on April 30th. In my opinion this year's meeting was the best in terms of the quality of questions and answers by Buffett and Munger. There has been a lot of information published on the annual meeting and I've included the most important below:

Required Reading:

The best transcript of the Berkshire Hathaway Annual Meeting By Ben Claremon of Inoculatedinvestor.com

Official Releases:

Information Regarding Trading in Lubrizol Corp. Shares by David L. Sokol (transcript of comments made during the annual meeting and the audit committee report)

Berkshire Hathaway 1^st Quarter Earnings

Interviews And Other Readings On Buffett, Gates, Munger:

Complete transcript of comments made by Warren Buffett on CNBC after the Annual meeting

16 minute interview with Charlie Munger on CNBC

Hour long interview with Warren Buffett and Ajit Jain while they were in India

Warren Buffett Watch From The Omaha World Herald

CNBC Transcript: Warren Buffett on Osama Bin Laden, the U.S. Economy, and the Sokol Scandal

NY Times coverage of the annual meeting

Buffett and Welch on Bin Laden’s death (CNBC)

CNBC interview with Buffett discussing the Sokol situation

CNBC interview Buffett on the future of Berkshire Hathaway

Charlie Munger discussing the Sokol situation on Bloomberg

Fox Business interview with Munger, Buffett, Gates and Decker on what books to read and leaving legacies

Fox Business interview with Buffett and Munger about the economy

Buffett and Gates on the economy with Fox business

Buffett says Bin Laden’s death not a market factor on Fox Business

Fox Business interview with Buffett and Gates on the Sokol situation

CNN Charlie Munger on Trump as President

Yellow BRKer 2011 Gathering At The Berkshire Hathaway Annual Meeting

noreply@blogger.com (Alex Bossert) — Fri, 25 Feb 2011 02:14:00 +0000

Berkshire Hathaway shareholders from all online communities are welcome to an unofficial gathering on Friday, April 29, 2011.

You are invited to join as fellow shareholders unofficially gather on Friday, April 29, 2011 at the DoubleTree Hotel in Omaha to meet and have fun, starting at 4:00 pm and you can linger until 7:00 pm (or longer). There will be a short program at approximately 5:00 or 5:30.

This is a casual atmosphere, with light snacks available. It's a "happy hour" type of gathering - not a formal dinner or anything of that sort.

The DoubleTree is located on 16th and Dodge. There may be some street parking, otherwise, one can use the parking garage with an entrance from the South at 16th & Dodge street, just east of the First National Bank.

Yellow BRKer Details and Registration

Pabrai Investment Funds Annual Meeting Notes

noreply@blogger.com (Alex Bossert) — Tue, 28 Sep 2010 17:25:00 +0000

I attended the Pabrai Investment Funds annual meeting in Chicago last Saturday. Mohnish did a great job answering questions, as usual. I've been lucky enough to get to know Mohnish over the past few years. Mohnish is one of the best fund managers in the country. He is one of the most genuine people I know and like Buffett he is always enjoying his job and cracking jokes.

Here are my notes from the 2010 Pabrai Investment Funds Annual Meeting in Chicago:

Prepared Comments:

The meeting started with an overview of how the fund has performed. Since the fund was started in 2001, it has returned 15.1% annually compared to -1.5% for the S&P 500.

$100,000 invested in the fund in June of 2000 would be $408,000 today.

Mohnish’s goal is to beat the index by 3% annually.

This past summer 3 interns worked part time on the checklist 2.0. They identified mistakes by great investors that resulted in a permanent loss of capital and analyzed why the mistakes occurred. They looked for commentary by the fund managers on these mistakes. They found that these investors almost never discussed their mistakes.

The biggest mistake was an investment in AIG by the Davis Fund which resulted in a $2 billion loss for the fund.

Mohnish said that the checklist is a great weapon in the Pabrai Funds arsenal.

Mohnish then went through one winner and one loser in the portfolio.

The worst investment during the period was Ternium which was actually sold at a small gain.

The winner he discussed was Teck cominco. This is the best investment the fund has ever made. The Pabrai Funds made an 8x return in only 3 months. Mohnish invested because they have some of the lowest cost mines in the world. The reason they were so cheap was because of a liquidity mismatch on the balance sheet. It had a large amount of debt coming due in a year. Mohnish felt that if they weren’t able to refinance the debt that they could sell assets piecemeal because of their highly diversified operations. In the worse case, the company would be worth a lot even in reorganizations because its book value was so high.

Question and Answer:

How Long did you follow Teck Cominco before buying?

Mohnish said he spent less than 5 days researching Teck because there were so many bargains at this time. Teck had a very solid moat because it was the lowest cost producer. To find Teck he looked at industry cost curves and paid attention to the lowest cost producers. The most important question to figure out was the liquidity mismatch.

Thoughts on Fairfax?

He doesn’t discuss current holdings.

Why don’t you discuss current holdings?

If investors get in the habit of discussing their investments they may end up suffering from commitment bias. If they constantly talk about how great a company is, they may suffer from a bias that could impair their judgment.

What are your views on position sizing?

His allocation policy changed in 2008 to reflect slightly elevated investment risks of his investment baskets and prior mistakes. If he has 10% positions it’s very hard to recover from a mistake. He discussed his new allocation framework with Charlie Munger who disagreed at first. After Mohnish explained it further, Charlie agreed that Berkshire Hathaway has achieved success with a more diversified portfolio. Mohnish talked about basket bets. When the risk is slightly elevated he will buy a basket of companies with small weightings. For example, he said he is currently researching companies in Japan. If he ends up buying companies there, he will buy a basket of companies each with small weightings in the portfolio. He said stocks there are very cheap.

What attracts you to a business?

When he finds a company that looks interesting he starts by thinking as a skeptic. He looks for something that will prove him wrong. He looks for areas of extreme mispricing. It has to be very undervalued but he also has to be able to understand it. He thinks there may be value in Coke bottlers in Japan. The Nikkei has done nothing for 27 years.

Has the increasing size of the fund negatively affect performance?

The performance of the fund has not been affected by size or fund inflows. He said that the fund is sitting on a lot of undervalue assets.

Has the economic turmoil changed your model?

Mohnish said he has more of an appreciation for macro issues than he has in the past. He also said that some macro trends make sense to base investments on. But the majority of macros trends such as inflation and interest rates are very difficult to predict and he doesn’t make judgments on those.

What are your thoughts on the financial industry?

Understanding management is key. You want to look for competent and honest managers. Because of the high leverage, management cannot make any mistakes in reserving. Also, it’s very difficult for outsiders to understand reserving. He couldn’t understand Citibank.

How much time do you spend on the balance sheet of companies you invest in?

Before he invested in Teck Cominco he read the last 8 years of annual reports. He spends a lot of time on the balance sheet.

What’s your philosophy on timing buying and selling?

He expects to be wrong in the future on selling. He said its fine to sell to early. If a stock goes down after he buys it that’s fine as long as he is still right about intrinsic value and he has dry powder to invest.

What did you identify with the checklist project?

The mistakes were concentrated in 08-09 and included a lot of financials. A lot of the mistakes were similar so he just picked a few. He analyzed Longleaf’s investment in GM. Longleaf’s management discussed the GM thesis in its reports. The mistake they made was they missed the forest from the trees. They missed the big picture. They figured that because GM did so well in the truck market that that would carry them through. They missed the fact that gas prices would rise to $3. He also said that he greatly respects these managers but that it’s important to learn from them. Longleaf also made the mistake of looking at the wrong variables.

How do you know where the edge of your circle of competence is?

If you have to ask yourself that question when looking at a company, then it’s probably beyond your circle of competence. You have to be honest with yourself. In the case of the Japanese companies he is researching, he has no interest in American listed Japanese companies. He will use the basket approach to Japanese companies because of the unfamiliarity. He also said that these Japanese companies are extremely cheap.

A business owner in the audience said after analyzing his own mistakes he noticed many of his mistakes were repeated. He asked if Mohnish had made a mistake more than once and was susceptible to reoccurring mistakes in one area?

Chris Davis wrote about a mistake he made in 2002. He ended up making the same mistake again in 2008 with AIG. Buffett made the same mistake twice as well with the original Berkshire Hathaway purchased and later on, with the Dexter Shoe purchase. Leverage is a very important factor to consider. One item on the check list is whether or not he suffers from any personal biases. The checklist forces him to take a step back.

Do you see any bubbles today?

Bubbles are hard to spot. Real estate in certain parts of China is probably a bubble. There are many bubbles around all the time. He mentioned a book called Trendwatching.

What’s your philosophy on investing in foreign markets?

He said that investing in US and Canadian companies that are driven by Chinese factors would be of interest to him. It’s important to understand foreign growth. You have to watch out for bubbles. China and India have good prospects but there may be an overall bubble. He’s very reluctant to invest in China but he’s interested in benefiting from Chinese growth. He skips Chinese companies because of accounting.

What does he think about natural gas companies?

The industry may be subject to a disruptive shift because of technological changes. The low prices may be permanent but he has no idea. The only good way to invest would be at the bottom of the cost curve and he can’t find one. There is no choke point in natural gas unlike iron ore. Natural gas also has substitutes. Mohnish recommended the book, Rational Optimist. He talked about how cheap energy allows countries to create more fresh water which will allow more agriculture.

How do you prevent macro issues from blinding investments?

He’s learned to appreciate macro issues more than in the past. As an investor you can’t get a handle on all factors. So it makes sense to spread ideas out more. The micro factors trump the macro factors. The company has to be able to control its destiny. He looks for staying power so the company can withstand shocks.

This question came from an investor who has to pull out money for living expenses. He asked how he can get more visibility on what taxes will be?

Mohnish practices tax planning in the funds. He sells holdings between the funds to cancel capital gains. The statements sent to shareholders should give them a good idea what the expected tax rate will be. Mohnish is a big tax payer so he is very sensitive to tax issues.

Is your philosophy on portfolio allocation shifting more towards preserving wealth instead of growing it?

The Kelly Formula is only correct when making many bets. He always under bet the Kelly Formula. Since Mohnish is making few bets, the Kelly Formula doesn’t work. He never fully used the Kelly Formula because it would have told him to bet more heavily. Return of capital is more important than return on capital. If people redeem their money during down times that is permanently lost capital for those people.

Can you name some great companies that you’d love to own at the right price?

Ikea, In and Out Burger, Costco, the low cost mines owned by BHP and Rio Tinto. Great companies are all over the place across the world. There are great companies in India and China but and ownership issues exists over there. Pricing is also an issue. Ben Graham’s approach was to go to the store and buy what was on sale and Charlie Munger’s approach is to go to the store and wait for quality items to go on sale. He likes Charlie’s framework.

What extra work do you do to analyze financials?

He’s reluctant to own most financials. They do own Goldman Sachs. He’s read two books on Goldman. It’s a great business. He doesn’t have a problem with management ethos but it’s improving. It’s a very complex business. They have the potential to grow huge overseas because they have few offices overseas right now. Since it has opaque parts to its business he made it a basket bet.

Does checklist address good portfolio strategies?

No. The checklist deals with analyzing companies. Mohnish recommended that this person read the fundamental value investing books. Mohnish always tries to learn from others.

Would you be more interested in a more certain intrinsic value or a cheaper price?

Currently the fund holds a lot of cash as there is less cash in the fund he demands higher discounts for new investments. I wasn’t able to too write down most of his answer.

What’s your average cash level since 1999?

In a crisis, cash plus courage is priceless. Next times a crisis strikes, he wants more cash. Instead of jumping from his second best to his best idea he instead lets investments play out and clings to ideas instead of jumping around.

How does Mohnish spend his free time?

He does plenty of other things. He has a daily nap, plays racquetball and plays bridge.

The BYD Story

noreply@blogger.com (Alex Bossert) — Mon, 12 Jul 2010 22:41:00 +0000

I invested in BYD about a year and a half ago. Since then, I've been trying to learn everything I can about the company and it's founder Wang Chuanfu. Here is my investment write up of BYD:

Wang Chuanfu has been called the Thomas Edison of our time combined with the Bill Gates of China by Warren Buffett. Charlie Munger said it’s the best company in the world and the most amazing company he’s ever seen.

At the same time BYD is trading for $17 billion and should earn around $1 billion in earnings this year. It’s trading for around 12 times next year’s earnings. BYD already produces the number one car in China. All the upside of their electric cars and solar panels are priced in for free.

“It’s our company’s long-term target, to be China’s No. 1 automaker by 2015 and to be the world’s leading car maker by 2025,” - Wang Chuanfu

1. History:

Wang Chuan-Fu started BYD (the letters are the initials of the company's Chinese name) in 1995 in Shenzhen, China. A chemist and government researcher, Wang raised some $300,000 from relatives, rented about 2,000 square meters of space, and set out to manufacture rechargeable batteries to compete with imports from Sony and Sanyo. By about 2000, BYD had become one of the world's largest manufacturers of cellphone batteries. The company went on to design and manufacture mobile-phone handsets and parts for Motorola (MOT, Fortune 500), Nokia (NOK), Sony Ericsson, and Samsung.

Wang entered the automobile business in 2003 by buying a Chinese state-owned car company that was all but defunct. He knew very little about making cars but proved to be a quick study. In October a BYD sedan called the F3 became the bestselling sedan in China, topping well-known brands like the Volkswagen Jetta and Toyota (TM) Corolla.

Link: http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/index.htm

Wang Chuanfu has been called the Thomas Edison of our time combined with the Bill Gates of China:

"This guy," Munger tells Fortune, "is a combination of Thomas Edison and Jack Welch - something like Edison in solving technical problems, and something like Welch in getting done what he needs to do. I have never seen anything like it." But Buffett and Munger and Sokol think it is a very big deal indeed. They think BYD has a shot at becoming the world's largest automaker, primarily by selling electric cars, as well as a leader in the fast-growing solar power industry.

One more thing reassured him. Berkshire Hathaway first tried to buy 25% of BYD, but Wang turned down the offer. He wanted to be in business with Buffett - to enhance his brand and open doors in the U.S., he says - but he would not let go of more than 10% of BYD's stock. "This was a man who didn't want to sell his company," Buffett says. "That was a good sign."

Wang typically works until 11 p.m. or midnight, five or six days a week. "In China, people of my generation put work first and life second," says the CEO, whose wife takes responsibility for raising their two children.

As for accumulating wealth? "I'm not interested in it," he claims. He certainly doesn't live a very lavish lifestyle. He was paid about $265,000 in 2008, and he lives in a BYD-owned apartment complex with other engineers. His only indulgences are a Mercedes and a Lexus, and they have a practical purpose: He takes their engines apart to see how they work. On a trip to the U.S., he once tried to disassemble the seat of a Toyota owned by Fred Ni, an executive who was driving him around. Shortly after BYD went public, Wang did something extraordinary: He took approximately 15% of his holdings in BYD and distributed the shares to about 20 other executives and engineers at the company. He still owns roughly 28% of the shares, worth about $1 billion.

The company itself is frugal. Until recently, executives always flew coach. One told me he was appalled when he learned that Ford, which lost billions last year, had staged a gala at the Hotel George V during the Paris auto show. By contrast, the last time BYD executives traveled to the Detroit auto show they rented a suburban house to save the cost of hotel rooms.

Sokol, author of a slim volume on management principles called Pleased but Not Satisfied, sized up Wang during that visit and decided he was an unusually purposeful executive. Sokol says, "Many good entrepreneurs can go from zero to a couple of million in revenues and a couple of hundred people. He's got over 100,000 people. Few can do that." When he got back to the U.S., Sokol told Buffett, "This guy's amazing. You want to meet him."

Even before visiting BYD, Sokol believed in electric cars. His people at MidAmerican have studied clean technologies like batteries and wind power for years because of the threat of climate change. One way or another, Sokol says, energy companies will need to produce more energy while emitting less carbon dioxide.

Electric cars will be one answer. They generate fewer greenhouse gas emissions than cars that burn gasoline, and they have lower fuel costs, even when oil is cheap. That's because electric engines are more efficient than internal-combustion engines, and because generating energy on a large scale (in coal or nuclear plants) is less wasteful than doing it on a small scale (by burning gasoline in an internal-combustion engine).

The numbers look something like this: Assume you drive 12,000 miles a year, gas costs $2 a gallon, and electricity is priced at 12 cents per kilowatt, about what most Americans pay. A gasoline-powered car that gets 20 miles to the gallon - say, a Chevy Impala or a BMW X3 - will have annual fuel costs of $1,200 and generate about 6.6 tons of carbon dioxide. Equip those cars with electric motors, and fuel costs drop to $400 a year and emissions are reduced to about 1.5 tons.

Link: http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/index.htm

Wang Chuanfu is the richest man in China with a net worth of $5.8 billion. He was also named one of the 40 most powerful people in China by business Week.

3. Competitive Advantages:

Cost advantage and quest to be the lowest cost producer:

“The big challenge now is to bring down the initial cost,” Li Lu told me. Eventually, BYD would like to sell the car for about the same price as conventional vehicles, and win over auto buyers by offering them lower operating costs and higher performance. “The only way to conquer this market is to provide a product that is comparable at the beginning and superior in the end,” he said “There are not many in the world that have comparable experience and expertise,” Li Lu says. “They seem to have a commanding lead right now.” The BYD technology is super safe, its batteries will last a long time and they will cost less than competitors”, he said.

Link: http://theenergycollective.com/TheEnergyCollective/65811

BYD’s electric Cars will be much cheaper than competitors:

BYD has also begun selling a plug-in electric car with a backup gasoline engine, a move putting it ahead of GM, Nissan, and Toyota. BYD's plug-in, called the F3DM (for "dual mode"), goes farther on a single charge - 62 miles - than other electric vehicles and sells for about $22,000, less than the plug-in Prius and much-hyped Chevy Volt are expected to cost when they hit the market in late 2010. Put simply, this little-known upstart has accelerated ahead of its much bigger rivals in the race to build an affordable electric car. Today BYD employs 130,000 people in 11 factories, eight in China and one each in India, Hungary, and Romania.

He started BYD with a modest goal: to edge in on the Japanese-dominated battery business. "Importing batteries from Japan was very expensive," Wang says. "There were import duties, and delivery times were long." He studied Sony and Sanyo patents and took apart batteries to understand how they were made, a "process that involved much trial and error," he says. (Sony and Sanyo later sued BYD, unsuccessfully, for infringing on their patents.)

BYD's breakthrough came when Wang decided to substitute migrant workers for machines. In place of the robotic arms used on Japanese assembly lines, which cost $100,000 or more apiece, BYD actually cut costs by hiring hundreds, then thousands, of people.

Link: http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/index.htm

BYD’s battery technology is around 5 years ahead of the nearest competitors such as Toyota, Nissan and GM. The F3DM is technologically superior top the Chevy Volt. The F3DM is priced at $22,000 and goes 50% farther than the Volt which is priced at $40,000. In addition the F3Dm is already being sold to retail customers but the Volt will be released near the end of the year.

http://www.slideshare.net/wrusso1011/090924-eu-co-c-pres-final-2

BYD takes apart the leading car modules of their competitors and copies them - but they don’t infringe on patents:

BYD's success as a revolutionary copyist has drawn mixed reactions, but of course business champions seldom pay heed to grumblings from those they defeat. When carmaking, for example, BYD found that reverse engineering can cut the cost of a new vehicle by more than one-third.

To develop good cars in the shortest time possible, BYD spends tens of millions of yuan every year buying and then dismantling the newest models built by manufacturers around the world. That's also how Wang set up the company's first battery production line. In those early years, a fully automated Ni-Cd battery production line from Sanyo cost tens of millions of yuan, so Wang decided to make one himself. He reverse-engineered the setup for an identical production line that cost only about 1 million yuan.

Auto stamping offers a good example of BYD's strategy. The company obtained a complete stamping plant when it bought Qinchuan, eliminating the need for expensive outsource production of new car body parts, which can take two years and cost 200 million yuan. As a result, BYD started making new stamps in eight months for 80 million yuan, and now it's building a third stamping plant near Shenzhen. "Why are our cars so cheap?" retorted a mid-level staffer at BYD. "Money is saved on every part, from engine to dashboard."

In hopes of skirting patent issues, BYD has a team with hundreds of people who study global patent intricacies. At the same time, BYD has begun applying for large numbers of patents; it was the biggest applicant after Huawei and ZTC in Shenzhen last year. BYD Sales Vice President Wang Jianjun says every automaker has to find its own path slowly. He notes that BYD is coming out with six, new models in 2010, all mid-range cars costing more than 100,000 yuan. "You'll discover that these new makes don't resemble anyone else's models," he said. "We made them ourselves."

http://english.caing.com/englishNews.jsp?id=100117245&time=2010-02-10&cl=111&page=all

BYD’s manufacturing process is much cheaper than their competitors

In terms of the sequence of steps, the manufacturing process at competing firms in Japan was similar to that at BYD. Nevertheless, the typical Japanese plant differed from BYD in several respects. First, most of the process in Japanese plants was automated. For example, the movement of material and work in process between production steps was performed by robotic arms rather than workers. Though robots were highly reliable—defects during assembly were estimated to be slightly lower than the 1.0% defect rate for the similar steps in BYD’s process—they were expensive. Wang estimated that each robotic arm cost approximately RMB 800,0001 and was depreciated over five years. Equipping a line to do final assembly would have required several robotic arms. BYD’s Shenzhen plant had more than 25 lines dedicated to battery production.

Second, Japanese factories contained significantly more dry-room space than BYD’s production facility. At these firms, nearly all assembly steps had to be performed in a dry-room environment.

At BYD, only the steps from the final formation of the cylindrical shell to the electrolyte-filling process required a dry room. Further, the BYD dry room was designed such that operators sat around its perimeter and worked on parts by putting their hands through airtight sleeves that extended into the humidity-controlled environment. Though not certain, Wang suspected that the amount of dry-room space in a Japanese factory was 10 times greater than that at BYD. Ironically, the smaller amount of dry-room space at BYD’s facility may have been the result of BYD not having access to information about the process used by its Japanese competitors. Wang noted, “Early in the design of our lithium-ion process, the Japanese plants were off limits to us, so we had to rely on our imagination to research and develop the battery technology and production process from other sources.”

Buying an auto company, however, was not for the faint of heart. The purchase price of roughly RMB 250 million seemed to be a bargain given the land that came along with it. But the existing equipment and lines at Qinchuan were in a poor state of repair and had no capacity for expansion. Wang estimated that building a new facility with a capacity of 100,000 vehicles per year and production lines for two additional vehicle models would require a further investment of between RMB 400 million and RMB 500 million. Furthermore, developing new vehicles would cost approximately RMB 100 million per product

According to a chart on page 21 of the Harvard report, BYD produces batteries at least 20% cheaper than Sanyo.

Harvard BYD Case Study

Access to rare earth minerals:

The 17 metals which are known as rare earths are a vital component in most of the world's new technologies.

As Newsnight's Economics Editor Paul Mason now reports these metals, 97% of which are mined in China, have the potential to shift the world's power away from the West.

Link: http://news.bbc.co.uk/2/hi/programmes/newsnight/8366603.stm

BYD is opening factories in resource rich areas to gain access to the rare earth minerals

BYD Co. Ltd. (SEHK: 1211), an indigenous manufacturer of rechargeable batteries and vehicles in China, will spend CNY 22.5 billion building a 5,000MW solar cell production base in the northwestern province of Shaanxi from 2009 to 2015, citing the local government's latest circular economy development strategy.

Link: http://www.tradingmarkets.com/news/stock-alert/byddf_byd-said-to-create-china-biggest-solar-cell-base-in-shaanxi-720577.html

Southern Shaanxi's mines are rich, while the province's northern region shares vast, sunlight-bathed deserts with Inner Mongolia. These geographic factors prompted government officials to look at applying resources from southern mines in solar energy projects, giving birth to a local photovoltaic industry.

The government plans perfectly meshed with BYD's development goals. So in 2008, the company signed an agreement with the government in the southern provincial city of Shangluo to build a 1 gigawatt solar battery production facility.

In the future, said an insider at the Shaanxi Development and Reform Commission, BYD plans to set up alternative energy facilities in Shangluo and the northern city of Yulin, including silicon smelting plants, solar battery production plants, and solar power stations. BYD's Shenzhen operation has been put in charge of researching the conversion and application of this new energy venture.

According to the southern Shaanxi scheme, BYD plans to invest 22.5 billion yuan in the province by 2015 and develop 5 GW worth of solar battery projects.

But the plans rely on government financing. Several official documents reveal that BYD's investment estimate is based on predictions of extremely low resource costs, as well as subsidies that nearly match BYD's outlays.

Nevertheless, the Shangluo government's land authority has already started working with BYD. A 27-hectare BYD New Energy Base is currently under construction on the city's eastern outskirts, and is expected to provide 1 GW generation capacity this year. The initial 450 million yuan investment includes a 50 million subsidy from the local government, and a 250 million loan from the Bank of China.

Moreover, Shangluo's government has spent tens of millions of yuan on resource extraction, discovering three silica mines and a vanadium mine. Development rights for two silica mines were awarded to BYD. On the provincial level, the Shaanxi government has set aside 800 million yuan for developing alternative energy, mostly for upstream solar energy production. Government sources said some of this money is earmarked for BYD.

In the future, BYD may tap into another government bank account tied to a 10 billion yuan fund for alternative energy investment at a Xi'an national civil aviation base.

In early 2009, BYD and Shaanxi's Information and Technology Department signed a batch of agreements linked to the alternative energy and auto industries. The provincial government promised to secure direct power supplies to BYD and other major companies at a polysilicon industrial park, offering preferential power prices.

Link: http://english.caing.com/englishNews.jsp?id=100117633&time=2010-02-12&cl=111&page=all

Chinas leading battery producer BYD Co., Ltd. starts building a solar cell project in Shangluo, Shaanxi Province. The company plans to invest CNY 450 million in the first phase of the project, which is expected to be able to turn out solar cells of 100 mega watts per year and create sales revenue of CNY 1.024 billion.

The first phase, covering a plot of land of 270,000 square meters large, will be built up one year later. The total investment in the project is expected to reach CNY 2.5 billion, local media said. It is the largest project in terms of investment in Shangluo City.

Shangluo has rich mineral resources, especially the high-purity silicon ore, which is the main raw material for solar cell production. Wang Chuanfu, chairman and president of BYD, had led a team to survey Shangluo at the end of this November and inked development contract of a solar cell plant with the local government.

Link: http://www.yourrenewablenews.com/news_item.php?newsID=18550

Massive R & D and 19,000 engineers:

GM or Toyota could not hire the amount of engineers working on electric cars that BYD has because the same engineers cost 10x more in industrialized countries.

Deploying the armies of laborers at BYD is an officer corps of managers and engineers who invent and design the products. Today the company employs about 10,000 engineers who have graduated from the company's training programs - some 40% of those who enter either drop out or are dismissed - and another 7,000 new college graduates are being trained. Wang says the engineers come from China's best schools. "They are the top of the top," he says. "They are very hard-working, and they can compete with anyone." BYD can afford to hire lots of them because their salaries are only about $600 to $700 a month; they also get subsidized housing in company-owned apartment complexes and low-cost meals in BYD canteens. "They're basically breathing, eating, thinking, and working at the company 24/7," says a U.S. executive who has studied BYD.

Link: http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/index.htm

Wang stresses that BYD, unlike Sony and Sanyo, has never faced a recall of its batteries.

Yet Wang felt that BYD differed from its Chinese competitors along at least one critical dimension—investment in R&D. Whereas other Chinese firms focused solely on production, BYD devoted substantial resources—roughly 2% of revenues—to both product and process R&D. Wang observed, “There are two types of Chinese companies in our industry. The first group focuses on the sales channel and does not care about the technology or the development of new components. Companies in the second group, including BYD, emphasize technology, and their competitive edge comes from the products they develop.”

Harvard Case Study

Chinese battery and car maker BYD Co. said Monday it plans to boost capital spending 59% in 2010 to expand its automobile production amid robust domestic demand.

Clear leader in electric cars:

Leading car makers are partnering with BYD to develop electric cars because BYD is so far ahead and the costs of developing their own technologies would be so expensive.

In March, the company announced a joint venture to develop electric cars in China with Mercedes. The idea is to combine Mercedes’ design excellence with BYD’s technological savvy, particularly with respect to batteries, and the Chinese firm’s access to its home market. “Daimler’s know-how in electric vehicle architecture and BYD’s excellence in battery technology and e-drive systems are a perfect match,” Mercedes chief Dieter Zetsche said at the time.

Link: http://theenergycollective.com/TheEnergyCollective/65811

The company more than doubled its sales to 450,000 cars in 2009. The car maker reiterated Monday its target of selling 800,000 autos this year.

BYD said it will launch the L3, I6, G6, S6, M6 all-new car models next year. The five new vehicle products include the sedan, SUV and MPV, of which only the M6 has been displayed to the public. All these new models will be priced between 100,000 yuan ($14,700) and 200,000 yuan.

The BYD F3 is the number one selling car in China and BYD as a whole is the 4th largest car company in China.

Link: http://online.wsj.com/article/SB10001424052748703909804575123261784247090

.html#printMode

BYD was the first company to get subsidies for its car buyers

In 2010, the Chinese government has expanded the trial cities for promoting energy-saving and new energy vehicles from 13 to 20. Five cities have be chosen as the pilot cities for the trial program, where private buyers purchase energy-saving and new energy vehicles can get incentives and subsidies, including Beijing, Shanghai, and Shenzhen etc.. As the first and only sedan chosen by National New Energy Vehicle Recommendation List, the E6 has been available to government agencies and corporations since Dec.15, 2008. The first private sales location is in Shenzhen as selected and will expand to other new energy car trial cities in China.

Link: http://www.byd.com/press.php?id=87

BYD could never compete with GM or Toyota in petroleum based cars, but electric cars are much simpler to engineer and BYD leads everyone in technology

Mr. Wang's strategy: capitalizing on the electric car's low barriers to entry. Few products are as complex to develop and produce as gasoline-powered automobiles, which are assembled with thousands of precisely engineered parts. But electric cars use only basic motors and gearboxes, and have relatively few parts. Aside from perfecting the battery itself, they're far easier and cheaper to build -- and that makes for a level playing field.

"It's almost hopeless for a latecomer like us to compete with GM and other established auto makers with a century of experience in gasoline engines," said Mr. Wang in an interview, pacing and juggling calls in BYD's headquarters on the outskirts of Shenzhen. "With electric vehicles, we're all at the same starting line."

Mr. Wang says BYD's lithium-ion battery uses an iron-phosphate technology that is chemically stable and thus "inherently safe." He says it doesn't overheat to the point where it can catch fire.

Mr. Wang, the 42-year-old Chinese entrepreneur, compares the simplicity of building electric cars to the simplicity of a digital watch. "Anyone can design and produce digital watches, but it's virtually impossible for a newcomer to match the precision of a Swiss wristwatch," Mr. Wang says.

Indeed, BYD's all-electric e6, has just two motors (45 parts each), one powering the front axle and the other the rear, and two gearboxes (60 parts each) to go with each of the motors. That means the whole system has 210 primary parts, excluding nuts and bolts. In comparison, BYD's F6, a gasoline-fueled vehicle, has a total of 1,400 powertrain parts: a V6 engine composed of 840 parts and a transmission with 560 parts.

Link: http://online.wsj.com/article/SB123172034731572313.html

BYD becomes the supplier of electric car batteries to other car companies:

Volkswagen and Mercedes Benz have announced they are partnering with BYD

The Lavida electric model is likely to have most of its parts sourced from Chinese producers, including the battery expert Build Your Dreams (BYD). VW’s German rival Daimler announced two weeks ago it was also partnering with BYD to build electric cars in China.

Link: http://webcache.googleusercontent.com/search?q=cache:JixZXU4kEUQJ:www.thelocal.de/sci-tech/20100312-25839.html+VW+e-Lavida&cd=2&hl=en&ct=clnk&gl=us

(Hongkong /Stuttgart) –BYD Company Limited (1211.HK) yesterday signed a Memorandum of Understanding (MoU) with Daimler AG (stock ticker symbol: DAI) to enter into a comprehensive technology partnership for the development of electric vehicles for China.

Link: http://www.byd.com/press.php?id=86

In a shockingly forthright appraisal of the Chinese auto market, Daimler CEO Dieter Zetsche laid out the harsh reality for the Chinese auto market, stating that petroleum-powered vehicles are not sustainable due to the massive demand, and that electric vehicles are imperative.

Speaking at an event in Beijing, Zetsche remarked “If you look at the population and the growth here, you quickly reach the conclusion that it would be unthinkable to provide these people with traditional gasoline- and diesel-powered vehicles. There just isn’t enough oil for that. So there has to be personal transportation that is not dependent on oil and is CO2-free to the greatest possible extent. In this regard, BYD is clearly a front runner.

http://www.autoguide.com/auto-news/2010/05/daimler-ceo-china-must-adopt-evs-gas-and-diesel-cars-not-feasible-for-their-market.html

The company hasn't yet decided whether it will enter the U.S. market, where the economics of electric cars are not as compelling. Sokol, who now sits on BYD's board, says BYD could instead become a battery supplier to global automakers.

Link: http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/index.htm

BYD’s batteries become connected to the grid to store solar and wind generated power:

BYD built a 2-MW demonstration energy storage system in a 40-foot mobile container for PacifiCorp, in Portland. It also has a 1-MW stationary demonstration storage project in its factory in Shenzhen, that is connected to the grid, and a 200-kW storage unit in a 40-foot container, that features four-hour discharge, as well as a 600-kW 40-foot storage container for 1.5-hour discharge.

Link: http://www.distributedenergy.com/forms/print-29196.aspx

"We've never really had storage capability on utility systems," Sokol told me recently, by phone. "Given the progress BYD has made on the technology of batteries for electric vehicles, the question is, how do we ramp that technology up so that we can use it for multiple purposes in the utility world? "Probably the most obvious is the ability to store intermittent renewable resources, such as wind or solar," Sokol said.

Put simply, cheap battery storage at scale would address one of the biggest drawbacks to wind and solar energy, which is that, unlike coal or nuclear power, they are unpredictable -- you can only make electricity when the wind is blowing or the sun is shining. "If you can store electricity when the wind blows, and have it available when you need it, that argument goes away," Sokol says.

Link: http://www.greenbiz.com/blog/2009/05/26/warren-buffets-big-battery-play

Eventually BYD will be the lowest cost producer of solar panels:

Wang said the company has a goal of reducing the cost of solar panels by 10 percent a year to make them more affordable to the general public.

http://www.contracostatimes.com/california/ci_14986910?nclick_check=1

BYD was first to the game. Started 10 years before everyone else:

Chinese battery and electric automaker BYD Co. has set up a plant to mass produce lithium batteries for its electric cars in Huizhou, south China’s Guangdong Province, according to the China Securities Journal.

BYD, partly owned by Warren Buffet, has injected around five billion yuan (about 731.5 million U.S. dollars) into the operation of the Huizhou plant, which produces rechargeable batteries, automobile parts and handset components, the newspaper Xinhua reported.

Facilities for the production of batteries for the company’s electric cars are almost ready now, since construction began in September last year.

The Huizhou plant, the first eligible for mass production of lithium-ion batteries that are core technologies of BYD’s electric cars, is seen as a key step in the company’s electric car manufacturing

Link: http://www.cleancartalk.com/clean-car-talk-daily-snapshots/chinas-byd-aggressive-lithium-battery-hybrid-bus-production/

According to the distributor of BYD in Shenzhen, since F3DM low-carbon dual-model electric vehicle going on market, 14 have been sold on the terminal market with total orders of more than 500.

According to relevant information, the actual price of F3DM has been raised by 50,000 Yuan from 169,800 Yuan for relieving the current contradiction of demand and supply. Comparing with other types of vehicle of BYD, the ordering time for F3DM low carbon vehicle will be longer. It’s said that some of the customers calling for consultation are from Hong Kong, Beijing and even oversea.

Currently, the basic condition for promotion of electric vehicle in Shenzhen has been increasingly mature. The first batch of electric vehicles firstly built by China Southern Power Grid in Shenzhen has been put into operation with two charging stations and 134 charging cords started. The two charging stations are designed to have 9 charging cabinets which could accommodate 18 vehicles at the same time.

http://www.szcpost.com/2010/05/byd-f3dm-snapped-up-in-shenzhen.html

On a conference call, Mr. Wang disclosed that in 1998 he had instructed 20 of his top engineers to quietly scale up BYD's cellphone-battery technology so that it could be used to power cars some day. They developed an all-electric car, a clunky vehicle called the Flyer that was just a step above a golf cart.

Link: http://online.wsj.com/article/SB123172034731572313.html

China is spending far more money and allocating way more resources than any of country for clean technology:

U.S. leaders want China's clean energy boom to drive technology exports and are sending a sales mission to Beijing this week. But Beijing wants to create its own suppliers of wind, solar and other equipment and is limiting access to its market, setting up a new trade clash with Washington and Europe.

The potential Chinese market is huge: Total investment in China in renewable energy by the government and private sector last year was $34.6 billion, nearly double U.S. spending of $18.6 billion, according to a report by the Pew Charitable Trusts.

Link: http://finance.yahoo.com/news/US-Europe-look-to-China-for-apf-2207328030.html?x=0&sec=topStories&pos=main&asset=&ccode=

Zhen Zijian, deputy director of 863 major projects for energy-saving and new energy vehicles in the Ministry of Science and Technology, said the projected number of electric cars sold will reach to 2.66 million units, which leads to some 21.2 billion kWh of electricity needed throughout the year. The electric mini car can be driven at the highest speed of 80 kilometers per hour and run 100 kilometers without charging.

He added that electric city buses and plug-in electric buses will also be produced by 2015. At that time, the output of electric vehicles will make up 10 percent of the total number of electric passenger vehicles. China National Offshore Oil Corp. is considering building battery-changing stations for electric vehicles, part of a broader push by the state-owned oil giant that could give a boost to electric cars in China's huge market.

China's intention, in addition to creating a world-leading industry that will produce jobs and exports, is to reduce urban pollution and decrease its dependence on oil. China wants to raise its annual production capacity to 500,000 hybrid or all-electric cars and buses by the end of 2011, from 2,100 last year. Electric cars have several practical advantages in China. Intercity driving is rare. Commutes are fairly short and frequently at low speeds because of traffic jams. So the limitations of all-electric cars are less of a problem.

Link: http://autonews.gasgoo.com/auto-news/1012912/China-to-sell-2-66-million-electric-vehicles-by-2015.html

The United States is poised to invest $172 billion over the next five years, which compares to investments of $397 billion in China alone, a more than four-to-one ratio on a per-GDP basis.

Link: http://thebreakthrough.org/blog/Rising_Tigers.pdf or http://thebreakthrough.org/blog/2009/11/rising_tigers_sleeping_giant_o.shtml

Charlie Munger said it’s the best company in the world and the most amazing company he’s ever seen. The partnership with Berkshire Hathaway will give BYD a huge amount of clout in the USA and around the world:

For the first time, BYD, the Chinese maker of cars, batteries, electronics, and solar power equipment, earns the No. 1 spot on Bloomberg Businessweek's annual Tech 100 ranking of tech's top performing companies. BYD (which stands for Build Your Dreams) has more than flourished: It even outperformed perhaps the hottest tech outfit around, No. 2 Apple. Apple and Tencent Holdings (No. 3) round out the top three.

Link: http://autonews.gasgoo.com/auto-news/1015283/BYD-Tops-Bloomberg-Businessweek-s-12th-Annual-Tech-100-List.html

Mr. Sokol also said MidAmerican hopes to boost its BYD stake if the chance arises. "If in the future there is an opportunity for us to continue to invest in BYD, we will be happy to increase our stake over time, but we will do it in cooperation with BYD," he said. Mr. Wang said an increase is "negotiable."

Link: http://online.wsj.com/article/SB125085247014949083.html

"How did BYD get so far ahead?" Warren Buffett asked Wang, speaking through a translator. "Our company is built on technological know-how," Wang answered. Wary as always of a technology play, Buffett asked how BYD would sustain its lead. "We'll never, never rest," Wang replied.

Link: http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/index.htm

Warren Buffett's MidAmerican Energy Holdings Co. named Chairman David Sokol to the board of BYD Co., after the U.S. company agreed to buy a stake of about 10 percent in China's biggest rechargeable batteries maker.

Link: http://www.bloomberg.com/apps/news?pid=20601080&sid=a4RH6K5uUB70&refer=asia

Bill gates gets a royalty on Computers, BYD will be a complete energy producer, thus getting a royalty on energy usage in China:

However, the company's first goal isn't making a mark with its cars. Right now it is focused on solar panels, aiming to make them popular enough that they cost less for consumers. Paraphrasing Bill Gates' ideas about the PC, BYD Chairman Chuan-Fu said he wants solar panels on every home.

After that, the company's next goal is to expand throughout the States, and only after that is done will it turn to building hybrid and fully electric cars here. BYD's new operations are expected to add several hundred jobs to the LA's employment rolls.

http://www.autoblog.com/2010/05/03/report-chinas-byd-to-locate-u-s-headquarters-in-los-angeles/

BYD insiders revealed to Autocar that the E6 was part of the company's ambitious plans to be a 'total provider of power' in China, meaning that it wants to control electricity generation, battery manufacture and the vehicles to use them.

Link: http://www.autocar.co.uk/News/NewsArticle/AllCars/239616/

BYD’s cars and solar panels are made with complete vertical integration:

Everything in the cars is made and developed by BYD except for the tires and windshield

This "human resource advantage" is "the most important part" of BYD's strategy, Wang says. His engineers investigate a wide array of technologies, from automobile air-conditioning systems that can run on batteries to the design of solar-powered streetlights. Unlike most automakers, BYD manufactures nearly all its cars by itself - not just the engines and body but air conditioning, lamps, seatbelts, airbags, and electronics. "It is difficult for others to compete," Wang says. "If we put our staff in Japan or the U.S., we could not afford to do anything like this."

Link: http://money.cnn.com/2009/04/13/technology/gunther_electric.fortune/index.htm

Wang observed, “Our goal is the vertical integration of the whole supply chain. Even for the design of tooling and molds required to make components, we do 95% of the work internally. This puts more processes under our control and allows us to get benefits in terms of both cost and quality.”

Harvard Case Study

The Number of automobiles per capita in China is a fraction of the USA’s. Motor Vehicles per 1000 people:

USA: 764
China: 30

Link: http://www.nationmaster.com/red/graph/tra_mot_veh-transportation-motor-vehicles&b_map=1

Expanding globally and opened headquarters in the USA.

"Like California, BYD is a company of firsts. They are leading China and the rest of the world into a cleaner, more sustainable future with their automobiles and renewable energy products while creating jobs and saving consumers money. I welcome BYD with open arms and look forward to growing California's relationship with China to mutually benefit the environment and economy."

BYD's Los Angeles headquarters will be responsible for sales, marketing, and research and development for its automobiles and energy products, which include solar panels, LED lighting systems and home and grid level energy storage units through BYD's unique iron-phosphate batteries, Schwarzenegger's office said in a statement.

Link: http://news.xinhuanet.com/english2010/china/2010-05/01/c_13274586_2.htm

MidAmerican Chairman David Sokol, who was also interviewed in Xian, said MidAmerican is ready to assist BYD's foray into the U.S. auto market in "any way we could be helpful." MidAmerican also might invest in BYD's new initiatives in the U.S., which, in addition to automobiles, could involve solar panels and battery technology for power utilities.

Link: http://online.wsj.com/article/SB125085247014949083.html

BYD has recently announced plans to distribute cars in the USA, South Africa, Ghana, Germany and all over Europe, Australia, South America

BYD has backing from the Chinese Government:

BYD is receiving subsidies, land and low cost resources from the Chinese government

"The cooperation could involve the establishment of industrial standard for electric cars as well as joint investment and production," he told reporters at an auto forum in Shanghai yesterday without providing details.

China is aggressively pushing forward a plan to speed up the development of new energy vehicles, which include financial subsidies as well as 10 billion yuan (US$1.5 billion) investment to help car makers upgrade technologies.

Several car makers, including SAIC Motor Corp, Chang'an Auto Group and BYD Auto Co Ltd, have poured a huge amount of funds into investment and offered various new models of green cars to meet demand.

http://www.shanghaidaily.com/sp/article/2009/200911/20091113/article_419328.htm#ixzz0WhxEiucR

Electric vehicles may get discount at harbor: The Port of Los Angeles may become the first port to offer reduced tariffs for zero-emission vehicles imported into the United States, under a proposal expected to come before the Board of Harbor Commissioners this summer.

Plans call for offering a 15 percent discount on the wharfage rate for battery electric vehicles passing through the port. The reduced rates could go into effect by September, pending final approval by the harbor commission, the California Ports Authority and the Los Angeles City Council.

The proposal was introduced last week, when Chinese manufacturer BYD Auto Co. announced plans to move the company's North American headquarters to Los Angeles.

"BYD is a truly visionary company and the zero-emission tariff our port will offer is another great example of our strong desire to work with and attract global alternative energy companies to Los Angeles," Mayor Antonio Villaraigosa said. "By pursuing 21st century clean technology enterprises, we are building a foundation for our future, both economically and environmentally."

http://www.dailybreeze.com/news/ci_15038830

5. How did Buffett Find BYD:

This past weekend was the Berkshire Hathaway (NYSE:BRK.A / BRK.B) annual shareholder meeting. At one point during the Q&A, a questioner asked Warren Buffett about the status of Berkshire’s CIO candidates. Charlie Munger remarked that one candidate who he is particular close with was up 200% in 2009 with 0 leverage. Some people think that the person Munger is referring to is Li Lu, a fund manager who turned Munger and Buffett onto BYD.

Lu personally owns at least 2% of BYD, which rose 400% in 2009. I don’t know anything about his investments beyond that one position, but I know he is a huge believer in taking concentrated, high conviction positions. If that is the case here, BYD’s spectacular results must have contributed a lot to his returns for 2009 which may make a 200% for the year possible.

Link: http://streetcapitalist.com/2010/05/04/li-lu-berkshire-hathaway-cio-candidate/

Mr. Li is 32 years old. He wears Armani suits that he buys at a factory outlet; he lives in one of those bland modern towers on the East Side. While other Wall Street hotshots his age may have endured the trauma of not getting into the business schools or investment banks of their choice, Mr. Li has survived poverty, separation from his family (his parents were forced into labor camps) and a devastating earthquake. When he escaped to America after hundreds of his fellow protesters were killed in Beijing, he was one of the most wanted dissidents in China.

Link: http://www.gurufocus.com/news.php?id=92544

Fully Translated: Li Lu's Foreword to Poor Charlie's Almanack

noreply@blogger.com (Alex Bossert) — Tue, 22 Jun 2010 23:05:00 +0000

Li Lu has been named as a possible successor to Warren Buffet and Charlie Munger as Berkshire Hathaway's CIO position.

Here is some brief history:

He was a student leader of the Tienanmen Square protests in 1989. He then fled to the United States because he was named one of the most wanted people in China.

Li Lu's Wikipedia page

After moving the the US, he became one of the first student to triple major a Columbia University getting a degree in economics, law and an MBA simultaneously.

In 1997 Li Lu started Himalaya Capital. From the inception of the fund in January 1998, the fund returned an annual compound growth rate in excess of 29%. In 12 years, the capital grew more than 20 fold.

Himalaya Capital web site

Could Li Lu be the next CIO of Berkshire Hathaway?

Li Lu and Charlie Munger are good friends

Charlie Munger is an investor in Li Lu's investment firm

He convinced Charlie Munger and Warren Buffett to buy 10% of BYD. Click here for those unfamiliar with Berkshire's purchase of BYD

Li Lu is the only investment manager that Buffett and Munger have praised in the past few decades

Himalaya Capital has an office in the same building as Charlie Munger

Charlie Munger made a comment at the annual meeting about one of the four CIO candidates being up 200% in 2009 with no leverage. Based on Li Lu's holdings (his returns aren't public), his firm fits this criteria.

--------------------------

More Links:

GuruFocus: Another Berkshire Hathaway CIO Candidate

Li Lu: Bershire Hathaway CIO Candidate? By Street Capitalist

Warren Buffett's BYD: Revving Up, Fast

Finally, in May 2010, Li Lu helped to translate and wrote the forward for the Chinese version of Charlie Munger's book “Poor Charlie’s Almanack."

The translated version can be read here. Thanks to Enoch Ko

Berkshire Hathaway and Wesco Financial Annual Meeting Compilation

noreply@blogger.com (Alex Bossert) — Fri, 07 May 2010 23:56:00 +0000

I included videos, transcript notes and just a few articles of commentary, in this compilation. There were hundreds of articles published on the Berkshire Hathaway Annual meeting and most just comment on what Buffett and Munger said in the meeting. I think it’s much more worthwhile to just read the transcripts and skip the analysis by journalists. I tried to include only links that are worth your time to read or watch. This is only a fraction of the information published on the annual meetings.

Wesco Annual Meeting Notes:

From the Motley Fool

The best meeting notes from InnoculatedInvestor.blogspot.com

Berkshire Annual Meeting Notes:

The notes I posted on Tuesday and by far the best notes from the 2010 annual meeting.

More annual meeting notes. These include comments on the Berkshire Movie.

Study referenced by Buffett and Munger at the annual meeting regarding rounding of EPS numbers by public companies which suggests widespread earnings management by public companies

Warren Buffett Interviews:

Transcript of a recent CNBC interview

Warren Buffett: All Our Businesses Seeing a Big Upswing in March - Fox April 30th

Omaha.com has lots of articles on Buffet and the annual meeting. Including notes from past annual meetings back to 1982, pictures of Buffet from his early days as well as this year’s annual meeting, and many other articles, videos, interviews etc of Buffet over the years.

FOX: Warren Buffett - I don’t see anything wrong with Goldman.

FOX: Gates, Buffett on Burlington Northern Deal

FOX: Buffett, Munger Gates on derivatives and more

FOX: Gates, Munger and Buffett on Financial Regulation

FOX: Gates, Buffett on Burlington Deal

FOX: Gates, U.S. Has Best System for Entrepreneurs

FOX: Gates, Buffett, on Berkshire succession

CBS: Buffett, On the housing recovery

Buffett: What needs to change

Charlie Munger Interviews:

26 min interview with Munger on CNBC

Munger on Insurance Prices

Berkshire's Munger Interview on Goldman, Regulation

Munger on Goldman Sachs

Munger on Financial Reform

Interviews with Berkshire Hathaway executives and other links of interest:

David Sokol Interview

Markel Annual Meeting Notes -By Innoculatedinvestor.blogspot.com

Peter Buffett (Warren Buffett's Son) Talks To TYT

Berkshire Hathaway Earnings Release

Buffett Turns Into One More Corporate Bubble: Alice Schroeder

Dave Sokol on BYD

Another interview with David Sokol

Clayton Homes CEO on Getting People to Buy His Products

Interview With the CEO of Shaw Industries

ACME Brick's CEO on housing

Interview with all three of Buffett’s children

Interview with the CEO of Borsheims

Interview with the CEO of Iscar

Interview with David Sokol on Net Jets

Liz Claman on the Berkshire Hathaway Annual Meeting

2010 Berkshire Hathaway Annual Meeting Notes

noreply@blogger.com (Alex Bossert) — Tue, 04 May 2010 21:08:00 +0000

This year was my fifth year at the Berkshire Hathaway Annual Meeting. My friend Ben Claremon took word for word notes of the entire 7 hour meeting, a truly impressive feat. I hope to get the Wesco Annual meeting notes posted soon after this weekend's meeting.

Complete Transcript of the Berkshire Hathaway Annual Meeting.

Berkshire Hathaway Annual Meeting/ Yellow BRK'ER Party

noreply@blogger.com (Alex Bossert) — Mon, 19 Apr 2010 19:00:00 +0000

This will be my fifth year at the Berkshire Hathaway Annual Meeting. If your planning to attend feel free to send me an email so we can meet in person.

Besides the annual meeting itself, the highlight of my experience in Omaha is always the Yellow BRK'ER gathering.

Here are the details:

Berkshire Hathaway shareholders from all online communities are welcome to an unofficial gathering on Friday, April 30, 2010.

You are invited to join as fellow shareholders unofficially gather on Friday, April 30, 2010 at the DoubleTree Hotel in Omaha to meet and have fun, starting at 4:00 pm and you can linger until 7:00 pm (or longer). There will be a short program at approximately 5:00 or 5:30.

This is a casual atmosphere, with light snacks available. It's a "happy hour" type of gathering - not a formal dinner or anything of that sort.

The DoubleTree is located on 16th and Dodge. There may be some street parking, otherwise, one can use the parking garage with an entrance from the South at 16th & Dodge street, just east of the First National Bank.

Click here to Register

Space is limited; if planning to attend please be sure to register in advance. To help cover the costs we are asking for a $5 suggested donation at the door.

Interview Of Alex Bossert By Classic Value Investors

noreply@blogger.com (Alex Bossert) — Thu, 01 Apr 2010 14:28:00 +0000

Mariusz Skonieczny of Classic Value Investors recently interview me.

He runs Classic Value Investors, LLC, an investment firm based in Schaumburg, IL. He wrote a book called "Why Are Investors So Clueless About The Stock Market," which I plan to review soon for this site. He also has a very good blog over at http://www.classicvalueinvestors.com.

The interview was published on Mariusz's site here.

Here is the interview:

Alex Bossert is a young investor who was recently featured in the book, Of Permanent Value by Andrew Kilpatrick. He writes a blog, Alex Bossert’s Thoughts on Value Investing, which I recently added to my resources page.

Mariusz Skonieczny, Classic Value Investors: I learned about you because Sandesh Trivedi, who is my friend and a subscriber of my blog told me that he likes your website. I checked it out and I agree with him. You became interested in the stock market when you were 10. Did you buy your first investment at that age? If so, you have a one-full year advantage over Warren Buffett who bought his first stock at the age of 11.

Alex Bossert: I began learning about the stock market when I was 10 and I purchased my first stock right after my 11^th birthday. My first investment was in shares of Wal Mart. What first got me interested in the stock market was a book touting the money to be made in internet stocks. Luckily, I didn’t take this book too seriously. The second book I read was How To Pick Stocks Like Warren Buffett by Timothy Vick. This is the book that got me hooked on investing and started me down the path of learning everything I can from Warren Buffett. The book started with stories of Buffett’s childhood businesses such as his idea of putting pin ball machines in barber shops. He also paid friends to go retrieve golf balls from local courses and then he would resell them. I got my first money to buy stocks from a similar business idea. So right off the bat I could relate to him.

Warren Buffett’s teachings on investing just plain make sense. Value investing rests on two very simple rules: buy businesses that you understand and only buy when they are trading for less than intrinsic value. It just made so much sense to me to think in this common sense fashion. As Benjamin Graham once said, “Investing makes the most sense when it’s most business like.” But for many reasons, only 5% or so of investors are value investors and the short term mentality of most investors provides a huge opportunity for value investors. I felt that I had discovered the holy grail of investing. Warren Buffett once wrote that the concept of value investing is like an inoculation – it either takes or it doesn’t – and when you explain to somebody what it is and how it works and why it works and show them the returns, either they get it or they don’t.

Mariusz Skonieczny, Classic Value Investors: You tend to look at smaller companies versus big giants. Why?

Alex Bossert: I don’t limit myself to small companies but I do focus my attention there. One of my largest holdings is actually a $23 billion market capitalization Chinese company called BYD. Warren Buffett recently invested in the company and it has been one of my most profitable investments.

I’ve always had a fascination for small companies because oftentimes they are overlooked. Many of these companies get no analyst coverage and the many hedge fund managers are too big to look at them. I focus on where I can find the greatest discrepancy between price and value and that is in small and nano caps. I’ve invested in companies that are smaller than $10 million in market capitalization.

Warren Buffett made his 30%-40% partnership returns investing in micro cap companies and that is what I’m trying to recreate. The Buffett partnership letters are a fascinating read. Particularly Buffett’s investment in Sanborn Maps found in the 1960 letter to partners: http://www.gurufocus.com/news.php?id=7227

One year ago was the time of a lifetime for value investors looking at small caps. In many instances a company would experience no impairment of intrinsic value but the stock might be down 60%. One example is Clear Choice Health Plans. In September of last year this company was trading for $11 per share. The stock declined about 60% in a year because of fears of what health care reform would bring. However, 50% of Clear Choice’s business is Medicaid which is Obama’s platform for covering the uninsured. It was unclear how healthcare reform would affect profit margins but revenue would definitely increase under Obama’s plan. The company was trading for just over 5 times earnings and for 40% of book value. The company had $28 per share of cash and investments, $11 of which could have been distributed to shareholders while still maintaining statutory minimums. Management appeared at the time to be willing to put this money to good use and was buying back a significant amount of stock. Factoring in the cash and investments, the business was being given away for free. In late December of last year the company announced it was being acquired for $26 per share.

Mariusz Skonieczny, Classic Value Investors: You call the management of the companies that you research. Do you also meet with them face-to-face? What do you ask them? How do you evaluate them?

Alex Bossert: I don’t go and meet with management face-to-face but I sometimes call with questions. Evaluating management is extremely important and I think the proxy statement is just as important as the annual report. When I call the management of a company I’m researching, it’s not to evaluate management. Instead I usually have questions about the business, financial statements or the industry.

Meeting with management usually isn’t productive because CEO’s are good salesmen and that’s why they are the CEO. Executives understand their industry better than anyone else and they are always friendly. They are very good at selling their point of view. It’s really hard to come away not feeling really good about what they said and this could cloud my judgment of the company or management.

I have an investing checklist with 70 or so risks to look for in an investment. I have 8 or so things to look for in evaluating management. To evaluate management, I look at what they’ve accomplished. I also listen carefully to what they say on conference calls and in the annual reports. I want honest management with a long term view. I look at how they measure performance and if they freely admit mistakes. One way to judge honesty is to look at how aggressive the accounting is. In addition, I look carefully at how they pay themselves. I want to know if they love the money or love the business. Do they have skin in the game and own a big ownership stake in the company relative to their salary? I favor executives who purchased the shares with their own money rather than with granted options. Are they buying shares or selling? These are the questions I ask myself when evaluating management and they are answered by reading the proxy and annual report, not by talking with management.

Mariusz Skonieczny, Classic Value Investors: Congratulations on being featured in Andy Kilpatrick’s book Of Permanent Value: the Story of Warren Buffett. How did you get to be featured in it?

Alex Bossert: Of Permanent Value is one of the first books I read on Warren Buffett. It is by far the most in depth of all the books written on him. My favorite aspect of the book is that Andy Kilpatrick has chapters on all of Berkshire’s acquisitions and explains Berkshire’s subsidiaries in depth. I’ve researched nearly all of Buffett’s acquisitions and why he invested so this was extremely useful. It’s a big honor that Andy asked me to be included in the book and I highly recommend people read the book.

Mariusz Skonieczny, Classic Value Investors: Where can people read your story from the book? Is the edition in which you are featured published yet?

Alex Bossert: I was published in last year’s edition. I was in chapter 205, pages 1169-70 for those who want to look it up. The 2010 edition is now out on Amazon for pre order and is due to be shipped in late April. The book can be pre ordered here. I’ve posted the chapter on me on my web site. The chapter can be read here: http://alexbossert.blogspot.com/2009/10/blog-post.html

Mariusz Skonieczny, Classic Value Investors: What is it like to be a high school student interested in the stock market? What do your peers think about your passion for investing?

Alex Bossert: I feel that success in investing is based on how much time and effort is put into it. The more investors read and the longer they invest, the greater the chances they will become successful. That’s why many successful investors started young or had a lot of practice before they became successful. I spend a lot of my free time reading about companies and studying the most successful investors. I’m fascinated by and enjoy the whole process. Because I’m so passionate about investing, all my friends respect my interest in the stock market. A few are somewhat interested in what I’m doing but none of them invest on their own. I’ve met a few people my age that are value investors mainly through my site and at the Berkshire Hathaway annual meetings.

Mariusz Skonieczny, Classic Value Investors: Can you tell us about a company that you invested in recently and why you think it was a good investment?

Alex Bossert: My favorite company right now is Nicholas Financial. I have an extremely detailed analysis on my site. Nicholas Financial is a very uniquely managed auto lender. Auto lending is a business that has been given a very bad name recently. Nicholas is a great company trading at a very cheap price. They have very high quality underwriting unlike many of their competitors that focus mainly on the FICO score. They go further in researching the creditworthiness of their customers than their competitors do and employees are paid directly based on the quality of loans they originate. They also hold all of the loans on their books with no securitizations.

In boom times Nicholas is unwilling to make bad loans and pulls back on credit availability. However, when the credit cycle turns down and their competitors suffer or go out of business, Nicholas remains solidly profitable and takes market shares away from competitors. While their competitors were going bankrupt last year, Nicholas’s profits declined from 20% return on equity to 10%. At the same time management was buying a lot of stock. The company also over reserves for losses every year and is constantly accreting unrealized losses back into earnings. The company was incredibly cheap last year and is still a good buy today.

Last year the stock declined from $8 to $2. I’ve read everything I can on Nicholas as well as researched their competitors. Because I understood the business so well, I was buying a lot of stock at less than $5 per share when other investors were selling based on fear. I knew it was extremely unlikely the company would have a margin call unless the economy got significantly worse than it was in March of last year. Currently, book value is $8 a share and I think the company is worth around $15 per share. The company should be able to earn around $2 a share in a few years and earnings are growing 10-15% per year. In the last ten years, shareholders equity has grown from $11 million to $88 million today. Here is a quote from a CEO I’m very happy to partner with: "When yields on loans look temptingly high, we always try to remember that the return of your money is more important than the return on your money."

Mariusz Skonieczny, Classic Value Investors: Thank you very much for the interview and I wish you good luck with your investment endeavors

Alex Bossert: Thanks for the questions.

Update On Convera

noreply@blogger.com (Alex Bossert) — Fri, 26 Feb 2010 04:01:00 +0000

I’ve had a few comments about my lack of posts on this blog recently. I’m having a very busy senior year in high school and I feel that with my more limited free time, I have for investing, I’d rather spend it reading and researching than posting more frequently. I feel no need to fill your email with useless posts and I will post once every two or three weeks on what I feel is most important. I think it makes sense to post few but very high quality posts.

I’m honored that my site has over 210 subscribers and over 33,000 page views. If you would like to subscribe and receive email updates when I post, please subscribe by clicking here. I’ve also enjoyed getting to know many of you. I’ve received emails from readers from all around the world. I really enjoy your feedback or questions at Alexbossert[at]Gmail[dot]com.

Update on Convera:

I sold CNVR two months ago because I no longer thought the transaction would play out as I originally wrote in my write up. The transaction was likely to take longer than expected and the cash burn was more than I expected in the 10Q filled in December. The 10Q in December also had different language as it relates to the distributions than the proxy statements. The most recent 10Q troubled me because it didn’t mention the two $2M distributions, which account for about $0.07 of value in the liquidation. They were still included in the original plan of liquidation and therefore by reference in latest 10Q. The distributions were likely to be less and stock was still trading at the same price as I bought at, so I sold.

As it turns out, the company distributed 10 cents per share February 8^th.Convera is trading for 8 cents right now and in the original proxy, management estimated that the company would pay out an additional 7.4 cents from here. So if you pay 8 cents now you might get 7.4 cents back and some shares in a potentially worthless company. So it’s not near buying range right now.

Companies in liquidation has been an area of the investment world that really interests me. A good example of of a liquidation play is my investment in Footstar. You can read everything I've written on the company here. Footstar worked out really well and with Convera, I just broke even on my investment. I would also say that it’s much less appealing to own liquidation plays after the first few major liquidating dividends. That is when it starts to take a really long time and management has the incentive to sit and collect their salaries.

Portfolio Update and Results for 2009

noreply@blogger.com (Alex Bossert) — Sun, 10 Jan 2010 04:48:00 +0000

Here is where my portfolio stood at year end:

Boss Holdings 9%
BYD Co 25%
Clear Choice Health Plans 6%
Cogo 10%
Nicholas Financial 25%
Convera 9%
Cash 16%

For the year 2009 my portfolio had a 160% return. Obviously this year was incredible and it’s unlikely to be repeated. My portfolio’s results over a 3 to 5 year span will be more reflective of how good of an investor I am and I shouldn’t be judged on one year alone. I had a nice surprise at the end of the year when Clear Choice Health Plans announced it was being acquired for a 167% premium. My portfolio did well because of the investments made around a year ago. Investments I made such as Nicholas Financial, Horsehead Holdings, Footstar, BYD and Clear Choice Health Plans were made when other investors were pricing many of these companies as if they were going out of business. In all of the names I mentioned above, the intrinsic values of these companies wasn’t impaired in the recession but were trading for 50-90% less than they were trading for only one year earlier.

A quick update of what I’ve been up to. I’m currently a senior in High School. I haven’t figured out where I want to go to college yet but I will be hearing back from schools I’ve applied to soon. This past summer I interned at a hedge fund in New York City. I was also featured in the book Of Permanent Value: The Story of Warren Buffett by Andy Kilpatrick.

I hope my blog is both interesting and profitable to readers. As always if anyone has any comments feel free to email me Alexbossert@gmail.com. I’d love to hear your feedback.

Error In Yesterdays Subscriber Feed

noreply@blogger.com (Alex Bossert) — Thu, 31 Dec 2009 16:44:00 +0000

If you received the post yesterday titled "Earnings Update" from two years ago, it was sent by mistake. Sorry for the inconvenience.

Happy new year to subscribers and readers of Alex Bossert's Thoughts on Value Investing.

Convera Corp.

noreply@blogger.com (Alex Bossert) — Sat, 05 Dec 2009 18:58:00 +0000

Convera is a liquidation play. Convera is trading for $.22 and the company estimates investors will receive $.26 per share in cash in the next 12 months and an additional $.11- $.19 after intellectual property is sold. The trading volume on Convera shares is small with around 150,000 shares traded a day.

According to Yahoo Finance, Convera’s business consists of “vertical search services to trade publishers in the United States and the United Kingdom. The company provides hosted white-label search technology and services, which enable publishers to generate Web traffic and online revenues by creating customized search applications. Its search platform helps publishers to combine site search, their proprietary content and an editorially vetted best of the Web into a vertical search application that provides an authoritative and comprehensive search experience for specialist audiences. Convera Corporation’s vertical search service comprises a suite of various components, including Web Search Platform that incorporates multimedia search of Adobe Systems Portable Document Format, image files, and other data formats; Convera Ad Service that allows publishers to manage and pursue search-based advertising revenues for their vertical search Web sites; and Publisher Control Panel, a self-service application that provides the publisher with the ability to control and tailor the Convera Web Search Platform and the Convera Ad Service for each vertical search site from a single interface. It also offers Converanet, an online search directory portal that contains various search engines in a single Web site. In addition, the company provides various professional services consisting of Web site customization; search engine optimization, marketing services, and training; and advertising sales kit development and training.”

Liquidation Time table:

Majority shareholders have already approved the liquidation:

According to the proxy statement: “Holders of our Class A Common Stock which represented a majority of the voting power of our outstanding capital stock as of the Record Date, have executed a written consent in favor of the actions described above and have delivered it to us on September 22, 2009, the Consent Date. Therefore, no other consents will be solicited in connection with this Information Statement.”

The Certificate of Dissolution hasn’t yet been filled:

“We anticipate that we will first take corporate action with respect to the Plan of Dissolution in accordance with our stockholder approval by filing the Certificate of Dissolution with the Secretary of State of the State of Delaware not less than twenty (20) days after the mailing of this Information Statement to our stockholders.”

The first cash distribution will take place shortly after the certificate of dissolution is filled with the state of Delaware.

Distributions:

The liquidating distributions consist of two parts. First, Convera will distribute a cash component worth $.26 per share. Second, after the certificate of dissolution is filled, Convera will merge its remaining intellectual property with VSW recieving a 33% ownership stake in VSW. Convera will sell its 33% interest in VSW or distribute it to shareholders. The company says the value of its ownership interest in VSW will be $.11 - $.19 per share.

Cash Component:

According to the proxy statement:

“In connection with the Merger, our stockholders will receive cash, plus a pro-rata share of an aggregate of one-third of the common stock of VSW. Our management estimates that our residual cash, after transfer of all of the operating assets and $3,000,000 in cash at closing of the Merger, drawn-down portion of the $1,000,000 line of credit, and various wind-down activities, will be approximately $14,000,000. We plan to distribute $10,000,000 shortly after the closing of the Merger, with the remaining $4,000,000 to be distributed in $2,000,000 increments at six months and 12 months after the closing of the Merger, subject to possible holdbacks for potential liabilities and on-going expenses deemed necessary by our board of directors in its sole discretion.”

The present value of this cash distribution, assuming a discount rate of 10%, is estimated at $0.26 per share. The calculation was performed as follows:

Value of intellectual property:

“Following the filing of our Certificate of Dissolution, we expect to consummate the merger of B2BNetSearch, Inc. and Convera Technologies, LLC, each a wholly-owned Delaware subsidiary of Convera, with VSW 2, Inc., the Delaware parent company of Firstlight Online Limited, a company in the business of online advertising sales and marketing incorporated as a company limited by shares in the United Kingdom (“Firstlight”), pursuant to, and subject to the terms and conditions of, an Agreement and Plan of Merger dated May 29, 2009, as amended and restated on September 22, 2009 (the “Merger Agreement”). As a result of the Merger, Convera will own 33.3% of the total outstanding capital stock of Vertical Search Works, Inc., a Delaware corporation and the indirect parent company of VSW 2 (“VSW”)."

“Both our CEO, Patrick Condo, and CFO, Matthew Jones, will join VSW after the effectiveness of the Merger. Mr. Condo has entered into a transition agreement with us and we intend to enter into a transition agreement with Mr. Jones. Additionally, it is the intention of the parties that Messrs. Condo and Jones enter into employment agreements with VSW.”

“In accordance with such agreement, we will pay Mr. Condo, among other benefits, an aggregate amount of $480,000 in cash in a lump sum on the 30th day after the closing of the Merger, provided that Mr. Condo has signed and delivered a general release in favor of us and the release has become effective.”

“Hempstead assessed the value indication associated with a one-third equity interest in VSW based upon the discounted cash flows methodology. Specifically, under a discounted cash flows methodology, the value of a company’s stock is determined by discounting to present value the expected returns that accrue to holders of such equity. Projected cash flows for VSW were based upon projected financial data prepared by our management. Estimated cash flows to equity holders were discounted to present value based upon a range of discount rates, from 25% to 35%. This range of discount rates is reflective of the required rates of return on later-stage venture capital investments."

The resultant value indications for the VSW component of the transaction, on a per-Convera share basis, are as follows:

The valuation placed on the 33% interest in VSW is $.11 - $.19 per share. Convera’s estimate of the value for the cash and valuation of VSW stock to be received in liquidation are within a range of $0.37 to $0.45 per share.

Herb Allen:

Herbert A. Allen has been a director of the Company since the effective date of the Combination on December 21, 2000 and was a director of Excalibur since June 2000. He has been President, Chief Executive Officer, Managing Director and a director of Allen & Company Incorporated, a privately-held investment firm, for more than the past five years. He is a member of the Board of Directors of The Coca-Cola Company. He is the father of Herbert A. Allen III.

The Allen family and Allen and Co. control over 61% of the company. Since Herb Allen is friends with Warren Buffett, I’d assume he is honest and trustworthy. He is also a very well connected person, knows a lot of power players, and with his own money on the line its good that the person in control has an interest in making sure the liquidation is completed quickly and efficiently. Both Herb Allen and his son are on the board of directors of Convera.

Conclusion:

Convera shareholders will receive the following as part of the liquidation:

1) $10m or $.187 per share upon closing of the merger
2) $2m or $.037 per share 6 months after the closing
3) another $2m 12 months after the closing plus 33% of VSW, estimated to be worth $.11- .19 per share.

At a purchase price of $.22, I’m being paid an 18% return to hold a free option on the value of VSW. The value of VSW is unknown but all the upside is free. One of the major risks in a liquidation play is executives have an incentive to delay the liquidation process and continue collecting their salaries. In this case, the executives are being hired by VSW so they don’t have to worry about losing their jobs. In addition the CEO, Patrick Condo will receive $480,000 30 days after the closing of the merger. Executives, especially the CEO have an incentive to move the liquidation process along quickly. Also, Herb Allen controls over 61% of Convera and he and his son are on the board. I like the fact that he’s friends with Warren Buffett and he will insure that the liquidation process moves along quickly because $8 million of his money is on the line.

The author owns shares in Convera.

Sold Horsehead Holdings

noreply@blogger.com (Alex Bossert) — Tue, 13 Oct 2009 14:59:00 +0000

I purchased shares in Horsehead Holdings back in March at $4.23 per share and I recently sold my investment at $11. I made at 160% return on my money in 6 months. I invested in Horsehead because it was trading for $150 million with $123 million in cash and a net current asset value of $150 million. I was buying at 40% of book value and the replacement value of the facilities is over one billion dollars. Not only was Horsehead incredibly cheap but it was a great company to. It’s the lowest cost producer of zinc in the world and the only company that can use 100% recycled feedstocks in its facilities. Horsehead’s competitive advantage in the zinc market is further benefited because its facilities are next to steal mini mills with long term contracts for the delivery of feedstocks. It would be extremely hard for a competitor to come in and hurt the company’s supply of low cost EAF dust. No other company has been able to develop recycling techniques comparable to those of Horsehead. Horsehead has a large moat in the zinc market. I also recognized the potential for higher economical uses of the iron by product that could be worth up to $13 million per year. In addition, the company continues to increase the percentage of feedstocks derived from EAF dust. 66% of the company’s feedtsocks are EAF dust and for every percent increase, margins expand.

Revenue decreased 64% in the first half of 09 because of lower realized prices for zinc and a decrease in shipments. Net income was negative $24 million vs. a profit of $24 million in the same period last year. The decrease was due to lower prices of zinc and less production. The company idled some capacity but fixed costs are still high. EAF dust fees were also substantially lower. A $22 million charge occurred due to hedging activities.

The company resumed operations at its Rockwood, Tenn., recycling facility in August. The company said it expects to restart one of two kilns at the Rockwood plant in mid-September. It had idled the facility as a result of the economic downturn.

In September Horsehead issued 9.1 million shares in a secondary offering at $10.50 per share less discounts and commissions of $0.525 per share and received $80 million in cash. “The Company intends to use the net proceeds from the offering for general corporate purposes, which may include capital expenditures, acquisitions, working capital, investments and the repayment of indebtedness.” After the offering there are 44.364 million diluted shares outstanding. Horsehead currently has $160 million in cash when the proceeds are factored in and a market capitalization of $500 million.

The secondary offering changes the dynamics for my investment in Horsehead. The market cap of the company is now around $500 million. The price of zinc has averaged about 90% of the cost of production. Unlike oil or many other commodities, zinc is so plentiful in the world that the price of zinc is based on the cost of production and has averaged around 90% of production. Predicting the price of zinc is impossible but looking at historical prices and the cost to produce zinc it doesn’t look like their will be any large upside from here. I have no competency in zinc prices and the price of zinc meant little to my investment in Horsehead. I invested because it was the lowest cost producer of zinc and it was trading below net current asset value. Horsehaed is no longer cheap and based on historical earnings it appears fairly valued.

Alex Bossert Featured in "Of Permanent Value: The Story Of Warren Buffett" By Andy Kilpatrick

noreply@blogger.com (Alex Bossert) — Thu, 01 Oct 2009 20:16:00 +0000

Last year I was lucky enough to be featured in a chapter of the 2009 edition of Andy Kilpatrick’s book “Of Permanent Value: The Story of Warren Buffett.” I was in chapter 205, page 1169-70. The chapter was titled “The Story Of Alex Bossert, Age 17.” Andy Kilpatrick is good friends with Warren Buffett and has been updating the book every year. The book is sold directly at the annual meeting every year.

Next year’s edition will be out in April and has a chapter on me and my friend Eric Schleien. Chapter 215 is titled: “The Alex Bossert Story, Age 18.” The chapter is on page 1215.

“Of Permanent Value” is considered by many to be the most extensive book about Warren Buffett and value investing.

You can view Andy Kilpatricks web site here.

You can purchase his book on Amazon by clicking here.

Click here to read the chapter that will appear in the 2010 edition of the book.

There is one factual error about Eric Schleien. He is currently going to school at the University of Buffalo. This will be corrected by April.

Pabrai Funds Annual Meeting Notes 2009: Huntington Beach California

noreply@blogger.com (Alex Bossert) — Tue, 29 Sep 2009 03:03:00 +0000

I attended Mohnish Pabrai’s annual meeting in Huntington Beach California last Saturday. I thought Mohnish did an awesome job as usual. I’ve been lucky enough to get to know Mohnish over the past few years and I grateful that he is so willing to share his ideas with others. Mohnish is both a friend and mentor. I admire his investing abilities and I also find him to be a very genuine person who like Buffett, is always having a good time and cracking jokes.

Here are my notes on the Pabrai Funds 2009 Annual Meeting in Huntington Beach California:

Presentation:

The formal presentation began with Mohnish discussing his checklist. He came up with the idea after reading an article in the New Yorker by Atul Gawande about checklists in medicine. He mentioned a few of the items on the checklist. Is the business simple to understand? Does the investment have a margin of Safety? Does the business have a moat? Mohnish went on to say that he has analyzed many of Buffett’s and other value investor’s mistakes as well as his own and added the mistakes to his checklist.

Mohnish cleaned house in the fourth quarter of last year. He sold many of the poor performers and weaker names and invested in natural resource companies and banks. He added 10 new positions in the 4th quarter of last year. The portfolio is now much stronger as a result. Mohnish's funds are up around 110% since the begining of the year.

He has also learned a lot from Seth Klarman about diversification. The old structure was geared towards 10 names with 10% of the fund allocated to each. Now, Mohnish has adopted a 3, 5 or 10 method whereby most positions will be 3 or 5% or the portfolio and if the seven moons line up he will allocate 10% to the investment. Mohnish said this should lead to better results.

Mohnish then discussed a few mistakes he has made. Compucredit is a subprime lender that was trading at 5x earnings and growing rapidly. The investment was sold at a 72% loss. The company has a win lose dynamic where is the company does well it is because they are preying on lower income customers.

Sears Holdings is another mistake. The funds lost 60% in Sears. Retailers are tough businesses. Mohnish is unhappy with himself for investing in this particularly because he wrote a chapter in his book Mosaic about why retailers are tough businesses. The thesis was that Lampert was very smart and would redeploy assets in better things. Sears also has below market leases and some very valuable brands. If it didn’t work out the real estate would be sold. But the problem is that 324,000 employees are between the investors and the assets. Sears cannot compete with Wal Mart.

An investment that worked out late last year was Level 3 bonds. Mohnish purchased the 3.5% 2012 convertible notes around November 4th for an average price of $432. The bonds have a $1,000 face value. He sold for $680. The bond markets were tremendously depressed during the crisis.

Questions:

Q: One of the first questions came from someone who wasn’t happy with Mohnish’s performance last year. From peak to trough the funds were down 70%. This person said that was inexcusable. He also wanted to know why Mohnish doesn’t pay attention to the macro view? To avoid the huge losses last year Mohnish could have raised a large cash position?

A: Mohnish said that for the most part investors were blindsided. Also, he can’t go short and can’t take on leverage. Even if he focused on the macro view, it would have been very difficult to have forecasted what happened last year. He does have some appreciation for the macro view though. But, its much easier to focus on situations where the probabilities are easier to handicap. Mohnish will benefit from inflation because of the natural resource investments he has. Going forward the changes for the funds will be more diversification, a little more emphasis on the macro view and higher cash positions. He is currently a net seller of stocks.

Q: Due to the events last year do you still wait for 3 years for your investments to reach intrinsic value?

A: Mohnish said he is still patient with investments and will wait 3 years for a particular investment to reach intrinsic value. The majority of the gains in the portfolio are long term gains. He will try to minimize taxes. He would never place a stop loss order.

Q: Would you invest in Chinese companies?

A: He said most lay outside his circle of competence. But he has made investments for the partnership in India. He also has one Chinese investment. When making foreign investments he would focus on the ethos of management. There are many great companies but its hard to make investments from foreign companies while being based in the US.

Q: Would you invest in Gold?

A: No. Gold is too hard to value. It has luster value but the intrinsic value is unclear. He has investments in gold through some of the companies he owns. He wants to invest in productive commodities and then find the lowest cost producer. Then he would be interested.

Q: Would you invest in warrants, options or short stocks?

A: Won’t look at anything except possibly covered calls. He has experimented in his personal portfolio and so far only lost money. To invest he would have to go through an amendment process with investors.

Q: How does the Kelly criteria fit with the 3, 5, 10, portfolio allocation method?

A: Pabrai told Munger about his diversification ideas and Munger interrupted him and said that he is going in the opposite direction then him. Pabrai said that since he’s running other people’s money he has to be risk averse. Berkshire has had way more than 20 holdings for a long period of time and done very well. Some large bets have gone wrong. The Kelly Criteria works if the inputs are correct. In some instances he placed the wrong inputs in the formula. Some of his large bets went wrong. He did the formula wrong. He’s moving to a greater cash position like Klarman. When stocks are cheap such as earlier this year he puts the cash to work and now he is a net seller. So over time the cash position will build up as ideas become less plentiful and then cash will decrease when investment opportunities become more plentiful.

Q: Do you use the checklist for portfolio strategy? For example, is there an item on the list that says that you won’t invest a lot in just one industry?

A: The checklist is company specific. The portfolio structure comes before the checklist comes into play. He wouldn’t put a large portion of the partnership in one industry. There will always be at least one issue on the checklist for even a good idea. If you exclude leverage 80% of investments are ruled out. There is always at least one issue. 10 of the questions on the checklist are on leverage, 5 on management. Such as; does management have a large stake in the company? The checklist puts the tradeoffs in front of you. Another checklist item is; does the company have union issues?

Q: An entrepreneur asked Mohnish for some advice on running a business.

A: Focus on what you’re passionate about. Find what you’re interested in and good at. Then hopefully people you know well will give you money.

Q: Did Mohnish had any confidence issues in the 4th quarter of last year?

A: Mohnish said he had no confidence issues but he was watching redemptions closely. He saw the most incredible opportunities he’s ever seen. He was very excited about the investments that were being made. He said that he looked for investments in businesses that had moats and products that were essential.

Q: Why is Mohnish closing the fund to new investors at one billion in assets?

A: He wants to focus on smaller companies. If he had a billion dollars, with 5% allocation he would put $50 million into each investment. To stay under the 5% threshold he would need under a billion in capital.

Q: Someone asked if he could explain his Pinnacle Airlines mistake?

A: Based on value metrics it was very cheap. It totally fails the checklist. There is no win/win dynamic in the business ecosystem. Pinnacle would rake in money as the carriers lose a lot of money.

Q: Could you discuss the lunch with Warren and Charlie?

A: The lunch was worth every penny. 54 different topics were addressed. Buffett said that if he could have lunch with anyone it would be Isaac Newton and then he stopped and said no it would be Sophia Loren. Mohnish told Warren that Harina really enjoyed the lunch but her real love in life is Charlie. Buffett then arranged a meeting with Charlie. He found Charlie to be gracious, like having lunch with your grandfather. Mohnish asked Charlie how he handled his fund’s poor performance in 73 and 74. Most of it is family confidential. Warren told his kids that the most important decision they make is who they decide to marry.

Q: Any book recommendations?

A: The Black Swan was good but could have been written in only ten pages. Atul Gawande’s article in the New Yorker about checklists is a must read. That’s the article that sparked Mohnish’s idea to create his checklist. Also, Atul has written two books, Better and Complications. Mohnish highly recommends both. Mohnish also mentioned the book, The Miracle: The Epic Story of Asia's Quest for Wealth by business journalist Michael Schuman.

Q: Why were there so many redemptions?

A: Last year 15% of the fund’s assets left. Mohnish feels bad because these people were not able to let the investments play out and lost out on a lot of upside. The reason was partly hardship redemptions and fear of equities. Some investors went completely to cash. Some sold everything and went completely into cash. Investors like to do the opposite of what they should. They invest after stocks have done well and sell after they have done poorly. Mohnish received the most new money in 05-07) and the most was taken out just before the best gains in the history of the fund.

Q: Was he forced to change his methods and ideas or was it voluntary?

A: It wasn’t a change rather it was an evolution. Munger says to be a continuous learning machine. But, underlying principles always stand.

Link to Pabrai Funds 2009 Annual Meeting notes from Chicago

Nicholas Financial Update

noreply@blogger.com (Alex Bossert) — Fri, 21 Aug 2009 17:11:00 +0000

Nicholas Financial had a good first quarter because of a drop in loan losses. Nicholas is able to make highly profitable loans as a lot of competition is hurt. The company has only a fraction of the debt to equity ratio of its peers but because of its unique lending strategy and its able to make an ROE of 20%+ in a normalized environment. I believe the company is worth at least $12 per share.

For more background information on Nicholas and my original write up click here

All my posts related to Nicholas click here

Nicholas Financial reported net income of $2.3 million for the three months ended June 30, compared to net income of $2.1 million last quarter and $1.6 million in the first quarter of 2008. Revenue for the just-ended quarter was $13.7 million, compared to $13.1 million a year earlier. Things are beginning to improve for Nicholas as loan losses, operating expenses and the cost of borrowed funds fell in the quarter. Net income rose 34%.

The biggest issue I see is the company needing to increase its credit line and renewing it in November of next year. This shouldn’t be an issue because they extended their credit line last year without a problem. The credit line is for $115 million and they have $104 million drawn down. The line of credit has one key covenant, which is that the pre-interest-expense, pre-tax income must be 1.25x interest expense at the end of each month. They're at 3.8x as of this quarter. The company should have no problem there.

The economic indicator that best correlates to Nicholas’s charge off rate is the unemployment rate. The pre-tax margin for the quarter was 6.34% and the provision for credit losses was 6.16%. Credit losses would have to double from here to bring Nicholas into the red, a very unlikely scenario, given that the provision for credit losses fell from 6.26% of average credit receivables to 6.16% in the current quarter. Net charge offs fell from 8.94% in the fourth quarter to 7.72% in the 1st quarter. Management anticipates losses absorbed as a percentage of liquidation will be in the 11%-16% range during the remainder of the current fiscal year. Losses as a percent of liquidation were 11% in the 1st quarter.

The loans the company is making are getting more profitable as their competition has diminished during the credit crisis. The average discount of new loans purchased has risen to 9.29% from 8.87% a year ago. At the same time the new loans are becoming more profitable they are also being made with more stringent credit standards:

The primary changes include; raising the minimum income required by the debtor to qualify for loan approval, reducing the maximum dollar amount that can be advanced for certain loan applications, and the maximum dollar amount that can be approved by a branch manager on certain approvals.

- First quarter 10Q

The average pre-tax yield over the course of the company’s history is around 9%. So when that level is reached again and it is likely that it will be at 9% or higher given that the loans being made now are of higher quality, due to lack of competition. With $216 million in net finance receivables at a 9% pre-tax margin, net income would be $12.5 million. At the same time the company is growing at more than 10% per year. With a multiple of 10x earnings Nicholas is worth $125 million or $12 per share.

Each of the 50 branches is budgeted (size of branch, number of employees and location) to handle up to 1,000 accounts and up to $7.5 million in outstanding finance receivables, net of unearned interest. To date ten of the branches have reached this capacity. The goal is to get all the branches to this level. If all the branches were operating at this optimum level the company would have $375 million in net finance receivables verses $216 currently. One issue for the company has been attracting qualified branch managers who are able to run a small business and at the same time be street smart and tough enough to collect from non paying customers. In the CEO’s letter to shareholders he said:

As a result of the spike in the unemployment rate, especially within financial services, we are now attracting a much higher number of quality job candidates than we have in the past. In many instances their company has either gone out of business or made considerable cut backs leaving them out of work or fearful of future layoffs. This recent change in the recruiting environment has allowed us to staff our company with several well-qualified people, making us stronger than ever. We believe this opportunity will help us to expand our Company, while our competitors pull back or in some cases, abandon our markets.

- Chairman’s Letter to shareholders 2009

During the recession management stopped all expansion to keep the balance sheet strong. Management is more confident with their current results so they have two more branches scheduled to open in the near future. This expansion will include new branch locations in Akron, Ohio and in Gastonia, North Carolina, which will bring the number of branch locations to 50 in 12 states. Also, the company mentioned, for the second time, that it is interested in an acquisition: The company “remains open to acquisitions should an opportunity present itself.” In ten years net worth has grown from $11 million to $88 million. Clearly the company has room to grow.
Nicholas is currently trading for $70 million with $88 million in shareholders equity. I believe the company is worth $125 million and I added to my position a few months ago at $5. Company insiders also thought the company was cheap and have been adding to their already large holdings.

Wesco Financial Annual Meeting Notes

noreply@blogger.com (Alex Bossert) — Wed, 13 May 2009 03:28:00 +0000

NOTES ON THE WESCO FINANCIAL ANNUAL MEETING

Thanks to Dah Hui Lau at http://dahhuilaudavid.blogspot.com/

May 6, 2009, Pasadena, California

The meeting was called to order promptly at 2:00 p.m. and carried on at a leisurely pace until ad-journment at 2:04 p.m. The question-and-answer session then commenced. However, in a style he later characterized as “Socratic solitaire,” Charlie Munger both asked and answered the first several questions.

SOCRATIC SOLITAIRE

How serious is the present mess?

“Deadly serious.” “You can’t tell what happens when people get disappointed enough of a dysfunctional civilization.” The Depression led to Hitler. The government has been right to react vigorously.

What caused the mess?

It was an example of a lolapalooza effect: the result of a confluence of causes acting in the same direction.

• Abusive practices in consumer credit, namely extending credit to people who couldn’t handle it, knowing they couldn’t handle it. Sometimes you have to resist sinking to the level of your competitors. But fomenting bad practices often becomes its own punishment. “If you do things that are immoral and stupid, there’s likely to be a whirlwind” that sweeps you away.

• The “scum of the earth” in mortgage credit who “rejoiced in rooking” their borrowers.

• “We had Wall Street go crazy,” pursuing any way of earning money short of armed robbery. In Merrill Lynch’s last purchase of a mortgage outfit, they knowingly bought “a bunch of sleazy crooks,” thinking that if it makes money, who cares that they’re crooks.

• Poor regulation and legislation. Some of the legislators genuinely thought they were being pro-social in helping poor people buy houses, but they weren’t; you need sound credit just as you need sound engineering. Some of the problem was Democrats pushing Fannie and Freddie to lend, some of it was “Republicans who overdosed on Ayn Rand” and thought unrestrained free enterprise was as good for the finance industry as for the restaurant industry.

• The repo system of credit allowed this: “one of the best ways to create excess credit ever invented.” Credit default swaps that let you profit if someone else fails are a terrible idea; in buying life insurance, you’re wisely required to have an insurable interest. Mark-to-model accounting on derivatives let both sides show a profit; “the accounting was phoney because all the customers wanted it phoney.” But Charlie’s never met an accountant who’s ashamed of his profession. People like Greenspan made what was going on respectable by endorsing it, but “it isn’t like free enterprise in restaurants”—more like legalized armed robbery. In the end, “We had to save a lot of these people whether we liked it or not.” To nationalize Fannie
and Freddie and then lower interest rates so good borrowers could buy houses was “very smart government.” In the old days, regulators kept silent about banks until they had to act, then announced a fait accompli; “put me down as dubious” about the public stress-testing. Charlie probably won’t like what Wells Fargo is made to do. Warren and Charlie think more highly of Wells Fargo than others do because of their low cost of funds. Charlie’s willing to put up with less than perfection from the government; on the whole, “it’s working out fairly well,” and “a lot of it has been done beautifully.”

What are the long-term consequences for Wesco?

“Practically none.” Wesco’s holdings will go back up, and indeed some of them have already gone
back up quite a bit. Its businesses will take advantage of the recession, Carnegie-style, to strengthen their positions.

What has the government done wrong?

• Ethanol is stupid. The use of fossil water and loss of topsoil isn’t accounted for, you barely get out more energy than you put in, and driving up the cost of food for the poor is “monstrously stupid.” But ethanol appears to be waning.

• Cap-and-trade is an “insane idea.” The Chinese aren’t going to decrease their emissions. But cap-and-trade might fade away too. What we should worry about is using up hydrocarbons too fast; they have uses, as in fertilizer manufacture, where we have no substitutes. Solar is the way to go; we don’t want everybody, North Korea included, having atomic power plants. Solar, a smart grid, and battery cars. Charlie thinks solar will come down in cost by 50%, but it’s worth switching even if it doesn’t; he agrees with Freeman Dyson that somewhat increasing the cost of energy wouldn’t be a big deal. “We should listen more to Freeman Dyson and less to Al Gore”; one knows how to think and the other doesn’t. China stands to gain from solar too; they’re choking on the emissions from the brown coal their power plants burn. Israel gets half its water from desalination driven by electricity. Cheap power could benefit the Arab nations too, and decrease tensions. “To me these are just ABC. Every bright high-school student in
the room should be nodding his head. . . but I’m not sure that’s the effect.” We could handle a rise in sea level; look at Holland. “Nervous Nellies” see trouble ahead, but we should see plenty. We do need to override obstructive local governments to get the smart grid built. We need more
of the Chinese approach. One of India’s problems is that it has too much due process.

How fast will improvement come?

Japan went all-out with stimulus and lowered interest rates to zero, yet they got stasis instead of a return to 4% growth. That would be terrible in this country, where there’s less social cohesion. “Japan is a very interesting and threatening example,” but Charlie doesn’t know how our case will play out. Japan wasted much of its stimulus filling every pothole three times and leveling every street. We should build that smart grid. Here’s Charlie talking economics, never having taken an economics class in his life. “I’m not apologizing,”and not impressed with academic economics.

What about stock prices?

Charlie’s agnostic on what they’ll do but would be willing to buy at current prices. Coca-Cola is worth what it’s selling for, and so is Wells Fargo. He wouldn’t expect miracles from them, but it’s generally a bad idea to expect miracles anyway. If you wait for a bottom, it’s often too late to buy by the time you know you’ve seen it. Charlie’s pretty fully invested himself. This might be a mistake, but that’s his thinking, and “you’re entitled to know, because you’re cultists.”

What kind of reregulation should come to the financial industry?

An investment bank that is too big to fail shouldn’t be allowed to be anything but a fairly boring
business, making markets, underwriting offerings, and so on. It used to be that way. Partners didn’t make much money. They were conservative people, they actually owned the business, and they’d seen the Thirties. It’s “crazy” to let bright young men buy what they want in the repo market with enormous leverage. Gambling on high leverage ought to be banned. We don’t need options exchanges or credit default swaps. A man doesn’t deserve high pay for ballooning a balance sheet at a tiny spread. “Any idiot could do it. In fact, many have.” We don’t need a world where large numbers of very bright people are trying to get rich by outsmarting each other. Charlie admires Obama for saying he’ll reduce the power of New York, but isn’t sure he’ll have the guts to do as much as Charlie would like done. It’s “not pretty” to make your money by being a better card player than other people, whom you lure into the game.

Buying Berkshire vs. buying Wesco?

“As always,” Berkshire is a better buy at current prices. Wesco gets bid up “because you people are cultists,” but if Charlie were buying today, he’d buy Berkshire. Berkshire is becoming a bigger and better known thing all the time; Wesco is just a byway, and it’s only an independent company by accident.

PRESS QUESTIONS

(Harper’s Magazine) If you were Secretary of the Treasury?

“They’ve been doing pretty well.” Paulson deserves credit, as do the current Secretary and Summers. They’re very able and will do a good job, though constrained by politics: sometimes you know what should be done but can’t do it for political reasons. Considering what they are facing, Treasury has done a good job.

(Motley Fool) If you were Obama, what would you incent?

Charlie would reduce the incentives to go to Wall Street. He’d the markets less deep and liquid, more inefficient. He’d promote the smart grid and do away with the ability of every state and hamlet to block it. He’d promote electric cars. As for Detroit, it’s an “example of a problem where, if you argued for the solution that had a chance of working, they’d bat you over the head and remove you.” Toyota has tough challenges; what hope is there for Detroit? Wringing out everything through bankruptcy and emerging with a single domestic company would have a 40% chance of working. What they’re actually doing has 0% chance except by constantly adding money. It wouldn’t be the end of the world if domestic auto manufacturing died out. It happened in England. Rochester used to prosper on the strength of Xerox and Kodak, and Buffalo has dwindled but is still a pretty nice place. This sort of change, some falling while others rise, is natural. “If someone my age can cheerfully die,” we can put up with the declining communities.

(Kathy Kristof) Many individual investors are disillusioned, seeing both Wall Street and Main Street businessas corrupt, and have sworn off stocks. Are they right to feel that way?

Individuals should maximize their Social Security benefit. That isn’t going away. After that, to expect a lot from stocks, bonds, or whatever is sort of irrational. The best way to achieve felicity is to aim low. Warren’s standard advice, low-cost index funds, is perfectly good for most people, and certainly better than trusting the average stockbroker. (The stockbrokers in the room are different, but “they’re not normal.”) It’s in the nature of markets to go down sometimes. Some people in this room can earn twice the normal return, and Charlie has himself, but he can’t teach everyone how to.

(Gurufocus.com) How do we avoid losses like last year’s? Or can we?

It can’t be done. “If you aren’t suffering a little right now, you haven’t lived a life that’s right.”

(Paul Larson, Morningstar) Book recommendations?

Outliers, by Malcolm Gladwell. “There’s a reason it’s a bestseller.” “I tend not to read self-help investment books. It’s kind of like soap operas: I figure I know all the plots.”

FLOOR QUESTIONS

How to hedge against inflation?

Charlie can remember the 2-cent stamp, the 40-cent-per-hour minimum wage replacing the 25-cent wage. Inflation didn’t ruin the investment climate over his lifetime. When the mass of people can vote, you have to expect inflation. It was a miracle that we had no inflation from 1860 to 1910. But is Berkshire shorting Treasuries or buying TIPS? Berkshire is “aware” that inflation is “the way of the world,” and we do what we can. But we bought a lot of utility bonds paying 9 and 10%. That’s not good if you have inflation, but it’s better than government bonds paying 3%. We don’t have a one-size-fits-all solution.

How can Berkshire invest in Goldman Sachs while inveighing against Wall Street behavior and excessive executive compensation?

The merits outweighed the defects.

What effect will problems in commercial real estate have on GE Capital?

“They will lose some money.”

Isdell and Kent seem much more successful at Coca-Cola than their immediate predecessors, yet it’s the same
company. Why?

The current CEO is “exceptionally gifted.” You can expect good results when a gifted CEO runs a
good company.

What will the business model look like for banks like Wells Fargo going forward?

They’re well situated and have bright prospects. More regulation wouldn’t be a surprise.

Can one teach executive leadership?

Some people are more teachable than others, just as some dogs are. Capitalism keeps filtering out the people who don’t do well and replacing them with people who do better.

What qualities do you look for in a leader?

Trustworthiness; good judgment. Warren’s right that an IQ of 130 is enough (though Berkshire wouldn’t be nearly what it is today if Warren’s own IQ was 130). Overreaching is the problem, and is encouraged by salesmen.

How do the long-term prospects for the investment climates in India and China compare?

If you’re asking whether Wang Chuanfu of BYD will do well, he’ll do “amazingly well.”
Why is growth emphasized? Are there limits to growth? Yes, of course. The material world is finite.

Berkshire’s invested a lot in railroads, but freight volumes are down, and a smart grid with solar and wind would be bad for coal hauling. What would change your views on railroads?

Burlington Northern would still be hauling freight. Railroads have competitive advantages over trucks. They look pretty foolproof; they’d be more foolproof if there isn’t a shift away from coal.

How long would it take to design a smart grid?

Charlie doesn’t know. We’ll need regulatory streamlining to get it built, but it’s perfectly doable.

(Whitney Tilson) Newspaper reports made the Berkshire meeting sound like a gloom-fest, and I wondered whether I’d been at the same meeting. How do you see opportunities today and their effects five years ahead?

Sure we have opportunities, and a smart grid would be good for Berkshire. The guys running Berkshire’s utility business are very good; for one thing, they get along with regulators by giving them what they’d want if they were regulators. There’s “considerable opportunity” for Berkshire to be bigger in utilities.

Human misjudgment?

Like sunshine, it will always be part of the world. At Berkshire, there’s less of it than elsewhere, and his provides an advantage. The best chapter in Outliers is the one about the guy with the 200 IQ who was a total failure in life.

Will there be oil to meet demand in the next five years?

We’re near peak oil, whether the peak is just behind or just ahead. On the other hand, there’s a lot of new gas, and that’s surprised everybody. The world will adapt to whatever the price of oil is, “because it has to.” Oil at $200 a barrel wouldn’t crater America. We’d change our ways and adapt.

What questions are you asking yourself? What should we be worrying about?

There are bad things to worry about. If Charlie were asked the odds of atomic weapons being used in the next 30 years, he’d put them “pretty high.” But you work on things you can change, and “suck up your gut” about the rest. Japan is still a decent place despite 0% growth, though it might not work out the same here; being monoethnic helps them.

What do you think about insuring, or buying, municipal bonds?

Charlie doesn’t want Berkshire insuring an endless amount of municipal bonds. A lot of politicians might yield to the temptation to throw their troubles on some insurer instead of on their taxpayers.

It sounded, at the Berkshire meeting, as though $100 million per year on advertising was maintenance cap-ex for GEICO, and the other $700 million on advertising should be thought of as growth cap-ex. Is that right?

Yes.

Have you read Snowball?

Yes. It’s an interesting book, covering a life in such detail. By and large it’s reasonably accurate, though any book that thick will have errors. And she made a lot of money.

What do you think of reverse mortgages?

They make sense, but they involve big commissions and dealing with frail old people, so Charlie is leery of them, as of anything sold on high commission to the old. Berkshire’s an example, in some ways like a university without walls.

Could we someday have documentation of decision processes released, even if long after the fact?

Berkshire’s example hasn’t had much influence. Charlie compared it to a surgeon he knew of who did a very difficult procedure. Other surgeons admired him but didn’t dare imitate him. Charlie likes Ben Franklin’s idea of not paying government officeholders and would like to see it extended to corporate directors. A fee of $250 thousand is a lot of money to, say, an university professor, and he’s going to do what it takes to stay on the board, and try to get on more boards. But university trustees serve without pay, and directing a public company is a similar public service. “You can argue that Walmart is more important than Harvard” in its cultural and economic impact. Being a director is interesting; why should you need to pay?

Will the coming inflation be like that of the Seventies?

Inflation coming is a good bet, but there’s not necessarily a good way to bet on it. TIPS have drawbacks. Real estate can drop in price, as we’ve seen. Keep your expectations reasonable.
Charlie told the story of a man who owned his house clear and had $1 million invested, letting him live in his house on the dividends. His broker talked him into selling puts on Silicon Valley bubble stocks. He lost his money and his house and took a restaurant job, all from trying to get more when he already had enough.

When will deflation stop and inflation start?

Omaha had no real estate boom and hasn’t had a bust; if you want a house in Omaha now, buy it.
Every market is different. Pasadena real estate is expensive, but it’s a well run city, and if Charlie wanted a house in Pasadena for his family to live in, he’d probably buy. “Now, I might buy it at foreclosure. . ..”

Why did China cease to lead in science 500 years ago?

A dumb, self-satisfied emperor and Confucian bureaucrats “like French Literature at Yale.”

Do you see something special about China?

Charlie likes Confucian values, especially the respect for elderly males. They have a strong work ethic. They’re family-minded. When Wang Chuanfu needed $300 thousand to start BYD, a cousin provided it to him. (That was the best investment the cousin ever made.) Their leaders are engineers: “That’s my kind of Communist.”

Is AIG still underpricing risk? Will the disruption in insurance create opportunities for Berkshire?

Scandal has been bad for AIG’s business. They’ve been “very unlucky.” They’ll survive but have a difficult hand to play. It could happen to Berkshire, or anybody else, if they make dumb decisions.

What’s the future of finance education, giving recent overwhelming evidence that diversification, for example, doesn’t work?

Charlie doesn’t think much of finance professors. Some of them try to turn finance into physics, but it can’t be done. He can’t tell you how to get a good academic finance education.

How can an individual shareholder, who can’t meet management, judge trustworthiness?

There’s no one answer. If you go to Mass. General and say you want to learn to read bone-tumor slides well, they can’t teach you. “No one’s any good at it who hasn’t been doing it for eight years.”

Are corporate lawyers’ fees too high?

Yes. On the other hand, if you can get into a good law school, you’re surrounded by bright people, half from the opposite sex. It’s a good place to meet a mate. And lots of people go to law school without intending to practice. But law in big firms has been too prosperous. Charlie has a lawyer friend who suggested that his firm cull one customer per year, on principle. Charlie thinks it’s a good idea, but the friend’s colleagues shot it down. Charlie’s big early success in business was firing lots of his customers, the ones who didn’t want to let the firm make any money.

What’s the future of the two newspapers you own?

The ordinary daily paper will perish or perhaps become something like public broadcasting, subsidized by one or two big backers.

What do you think about California tax-free bonds?

We have a crazy legislature, gerrymandered to contain only “certified nuts” from the left and the right who naturally hate each other. Charlie doesn’t know how it will play out. You can’t assume good will win. Sometimes evil wins.

Warren has said a weak dollar isn’t enough to resolve the U.S. trade deficit. How might it resolve?

Sometimes the completely unexpected happens. Who could have foreseen Margaret Thatcher and her sweeping changes after 20 years of Labour? “Warren is more pessimistic than I am.” Warren thinks China will tire of sending us goods in exchange for bits of paper. Charlier thinks China is gaining enormously, and the loss of purchasing power on their bits of paper is a small price to pay. The gains don’t show up in the equations of economists, but that means the equations are wrong. Getting good at manufacturing is a form of wealth.

Unrelated to the Wesco Meeting, here is a very good interview of Charlie Munger done recently by Stanford Law School.

Berkshire Hathaway and Wesco Annual Meeting Links

noreply@blogger.com (Alex Bossert) — Sun, 10 May 2009 17:49:00 +0000

I attended the Berkshire Hathaway Annual Meeting for the Fourth time in a row this year. Overall this year was definitely the best so far. The new structure of the meeting resulted in much better questions and all the poor questions were weeded out by the three journalists: Andrew Ross Sorkin, Becky Quick and Carol Loomis.

I have a compilation of links about the annual meeting:

Notes From Past Annual Meetings:

Whitney Tilson's Notes From Berkshire and Wesco Meetings (1998-2008)

Notes From the 2009 Annual Meeting:

In My Opinion the Best Notes I've Seen are From Ben Claremon at InoculatedInvestor.com

Notes From the Blog ValueHuntr

Notes From Buffettolgist.com

Morningstar's Notes

Interviews:

Charlie Munger on CNBC

Charlie Munger on PBS

An Article on Charlie Munger in the WSJ

Warren Buffett on CNBC: U.S. Economy Slow, Getting Slower...But Will Churn Eventually

Warren Buffett on the Squawk Box

Warren Buffett is up on Banks (CNBC)

Warren Buffett on CNBC: Maybe I've Lost my Touch, But I Beat the Market

Warren Buffett on CNBC: I Apply My Own Stress Tests to Wells Fargo

Wesco Meeting:

The Best Notes I've Seen From the Wesco Meeting

Notes From GuruFocus.com

Horsehead Holdings

noreply@blogger.com (Alex Bossert) — Tue, 17 Mar 2009 01:23:00 +0000

Business:

Horsehead Holding Corp. is a producer of zinc and zinc-based products with production and recycling operations at six facilities in five states. The company along with its predecessors has been operating in the Zinc industry for over 150 years.

Horsehead is currently trading for $145 million with $123 million in cash on the balance sheet and no debt. Book value currently stands at $358 million. The net current asset value is $150 million.

The company filed for bankruptcy in 2002 due to record low zinc prices, production inefficiencies, high operational costs, and legacy environmental costs associated with prior owners. Sun Capital purchased the company out of bankruptcy and the company went public in 2007 at $18 per share.

They are the largest refiner of zinc oxide and prime western (PW) zinc metal, in North America. The Company is the largest recycler of electric arc furnace (EAF) dust, a hazardous waste produced by the steel mini-mill manufacturing process.

Horsehead operates five hazardous waste recycling facilities for the recovery of zinc from electric arc furnace (EAF) dust and other zinc feedstocks. The five recycling facilities recycle the EAF dust into a zinc intermediate called CZO, which is shipped to their Monaca, Pennsylvania, facility for further processing into zinc metal and zinc oxide. The company’s processing capacity is 565,000 tons of feedstocks which will be processed into 150,000 tons of finished products. They own all of their facilities. Its products are used in a variety of applications, including in the galvanizing of fabricated steel products and as components in rubber tires, alkaline batteries, paint, chemicals and pharmaceuticals. The Company also owns and operates on its premises a 110 megawatt coal-fired power plant that provides it with a source of electricity and allows the Company to sell approximately one-fifth of its capacity on the open market.

EAF Dust recycling

The company is the largest recycler of EAF dust, a hazardous material produced in the steel mini mill process. For every ton of steel produced in the mills 30-40 pounds of EAF dust is generated as a byproduct. This dust contains about 20% zinc. About one million tons of EAF dust is produced in the U.S. every year. The full capacity of their seven kilns plus the flame reactor in Beaumont is 565,000 tons of zinc feedstocks and they are looking to expand that further.

The EAF dust collection market started in 1988 when EPA classified EAF dust as a hazardous waste. Horsehead’s predecessor company, New Jersey Zinc, was among the 55-60 different technologies that were developed to address the regulatory issue. However, none succeeded on commercial basis, except very few ones such as Horsehead’s. Horsehead’s ability to recycle EAF dust and use it as a feedstock for its Monaca smelter gives them a competitive advantage over traditional producers of zinc. The company has a lower breakeven point because instead of paying for its raw materials or mining for zinc, it receives a service fee from the steel mini mills to recycle their EAF dust. Acquiring their raw material at a negative cost gives Horsehead a competitive advantage over their competitors. Horsehead has the only zinc smelter in North America that can produce zinc metal and zinc oxide using 100% recycled zinc feedstocks. In addition their recycling process has been designated by the EPA as a “Best Demonstrated Available Technology” for the processing of EAF dust. In addition, EAF dust recycling operations provide them with a reliable, cost-effective source of recycled zinc without relying on third-party sellers

Horsehead gets about 50% of its EAF dust from Nucor steel. Many of their facilities are situated near Nucor’s plants. Most of Horsehead’s suppliers of EAF dust have been with them since the business started in the 80’s. The company recycles EAF dust for 7 of the 10 largest EAF producers.

Currently, 60% of their feedstocks come from EAF dust. There are significant new opportunities for Horsehead to increase the amount of its feed stocks that come from EAF dust. Since the EAF dust is acquired at negative cost, every increase in the use of EAF dust lowers their overall costs and increases margins. Currently about 1/3 of EAF dust production in the U.S. is deposited in landfills. The steel mini mill share of U.S. steel market has doubled over last 10 years and is expected to increase to 70% of the market by 2017 up from less than 60% today. The steel mini mill market is expected to continue to grow 2-3% a year with new projects under construction currently. Horsehead has many opportunities to increase the portion of their feedstocks that come from EAF dust.

Horsehead management has continually stated that they are looking to increase their EAF processing capabilities. In January of 08 they placed a second kiln into production at their Rockwood, Tennessee facility. This kiln will add 90,000 -100,000 tons to Horsehead’s feedstock capacity per year resulting in approximately 14,500 tons of additional finished zinc product. A new recycling facility is currently under construction in Barnwell, South Carolina near a Nucor Steel facility. The new facility will be able to process 160,000 tons of feedstocks per year and is expected to be complete in the latter half of 09. Management expects production of zinc will increase to 175,000 tons from around 150,000 tons per year currently due to these new projects.

Competitors

Horsehead is the only proven recycler of EAF dust and has no direct competitors. The competition comes from domestic recyclers of zinc secondary’s and miners. U.S. Zinc is a recycler of zinc secondary’s with the ability to produce 75,000 tons of zinc oxide per year. But, U.S. Zinc lacks the integrated processing and smelting capabilities that Horsehead has. The high price of zinc in recent years has attracted attention to the industry. Zinc Ox is currently constructing a plant in Ohio with output of 90,000 tons of zinc metal from dust sourced from a company called Envirosafe and Turkey. In addition, Steel Dust Recycling is currently constructing a plant to recycle EAF dust in Alabama and The Heritage Group has announced its intention to build an EAF dust processing facility in Arkansas. All of these facilities are years away from startup but could pose a risk to Horsehead.

Horsehead competes with landfills for EAF dust. But steel mills have many reasons to go to Horsehead instead. The mills that the company purchases its EAF dust from benefit from less exposure to potential environmental liabilities arising from disposing the hazardous dust in a land fill.

Over 75% of the zinc used in the U.S. is imported. Horsehead benefits from its close proximity to end users and lower costs of transportation verse foreign producers.

Operations

Horsehead sells its finished products based on a slight premium to the prior month London Metals Exchange (LME) price for zinc. The LME price dipped just below 50 cents per pound in 2003 and rose to a high of just of over $2 per pound in December of 2006. But since then the price has fallen to just below 60 cents per pound. The company has been working to reduce costs and their cash flow breakeven level is currently around 50 cents. In 2006 the company made $54.5 million which includes a $16 million management fee to Sun Capital. Excluding this fee, the company made $65 million in 2006 and $90.7 million in 2007. Net income for 2008 fell to $39.4 million due to the decline in the price of zinc and a decline in shipments, offset by a large gain due to hedging.

The future LME price of zinc will be affected by idled or closed zinc mining and smelting capacity growth in steel consumption and falling inventories. The current inventories of zinc have risen from the all time lows of a few years ago but are still well below historical average. Inventories have begun to fall as zinc mines and smelter capacity has been removed due to the low price of zinc. In 07, 11.3 million tons of zinc was consumed worldwide. This is expected to increase by 4-5% a year to 13.6 million in 2012. Meanwhile the supply of zinc is likely to be tight, when the economy improves. Brunswick, the world’s fourth largest zinc mine owned by Xstrata, produced 2% of the world’s zinc last year, is expected to be depleted by the end of 2010. It is likely that a decrease in capacity and curtailed capacity additions will cause the price of zinc to rise from the current historically low levels. Also, any stimulus such as the U.S.’s and China’s that includes infrastructure spending will increase demand for zinc.

In the 4th quarter cash provided by operations was $65.5 million. This includes $64 million in cash received from puts on the price of zinc which were sold in the 4th quarter. Sales of finished product were at an average zinc contained price of $.79 in the quarter. When the price of zinc declines the company is also affected by a lag in cost because the feed stocks going through the income statement were purchased back when prices were higher. When prices for zinc stabilize, costs will decrease further. Management expects that cash from operations will be negative for the first half of 09. But, cost cutting measures and an increase in the use of EAF dust instead of other feed stocks have pushed the breakeven point down to around $.50 per pound. Horsehead made $70 million on put options in 08 and they currently have puts for 90,000 tons of zinc at $.5 per pound through 09 to protect them if prices fall further.

Because of the large decline in the price of zinc the company has taken many actions to reduce costs and conserve cash. During the 4th quarter the company has: reduced output at the Monaca facility, suspended production of zinc oxide made from higher cost feed sources, took at extended outage at the recycling operations over the holidays, implemented a reduction in workforce, renegotiated feed prices and cut smelter output by 17%.

Untapped Value in Iron Byproduct

Horsehead’s operations produce about 350,000 tons of iron rich material that they sell into the aggregate market each year. This iron rich material contains about 175,000 tons of iron that the company believes they could sell for much more than they are getting currently. The company sells this material for about $1 per ton. The company believes they could sell the iron portion for $50- $75 per ton. The company successfully tested higher value applications for the iron rich material in the fourth quarter and expects to place its first order during the first quarter of 2009. The value of this byproduct could be worth $9-$13 million per year.

Undervalued

The company is the largest recycler of EAF dust in the world with no direct competitors. Horsehead's ability to recycle EAF dust gives them a competitive advantage over traditional miners and smelters of zinc. Horsehead is working to increase the portion of their feedstocks that are EAF dust and increase processing capacity. Horsehead also benefits from its close proximity to end users in the U.S. In addition, Horsehead has the potential to make a lot of money on the iron byproduct produced from their operations. Horsehead's stock has collapsed due to the decline in the price of Zinc. But, with their competitive advantages and large cash hoard, Horsehead can survive the recession. Horsehead is currently trading for $145 million with $123 million in cash on the balance sheet and no debt. Book value currently stands at $358 million and net current asset value is $150 million. The company made $65 million in 2006, $90.7 million in 2007 and $39.4 million in 2008. I believe Horsehead is very undervalued.

Sold Footstar

noreply@blogger.com (Alex Bossert) — Sun, 15 Mar 2009 17:44:00 +0000

In late November I purchased shares in Footstar at $2.8 per share. In January I received a $1 dividend as part of the company’s liquidation. In the 4th quarter the company received $53 million from Kmart for the remaining inventory and reduced the market price of their headquarters building to $12 million from $19 million. The current carrying value on the balance sheet is $6.2 million. In addition, 4th quarter earnings came in at the high end of my estimate at $25 million.

Last week I sold my shares for $2.63. In 3 months I made a 30% return on my investment in Footstar. I purchased Footstar because I believed that the company would be able to distribute at least $4.5 per share as part of their liquidation. After accounting for the recent dividend and the operating results for the 4th quarter which were better than I had estimated they would be, the company estimates it will distribute $2.65-$3.45 per share to shareholders. There is still a 30% upside from the current price using the best case. But, the sale of the headquarters building could take time especially in this environment. If the best and worse cases are averaged shareholders would end up with a 15% return on their money. With the opportunities available in the market today I’ve decided to sell my shares in Footstar.

Third Quarter Earnings

noreply@blogger.com (Alex Bossert) — Mon, 01 Dec 2008 21:06:00 +0000

Here is an update on the investments in my portfolio and my thoughts on third quarter earnings.

K-Swiss:

For the 3rd quarter revenue fell 10% pushing the company into a loss of $.1 million. Backlog continues to point towards declining sales. Total backlog is down 29%, comprising of a decrease of 35% domestically and a decrease of 25% internationally. K-Swiss is heading for a loss of $10-35 cents per share in the forth quarter. During the conference call manegment said that they are expecting a loss in 09 that could possibly burn through 10-20% of their cash. Separately K-Swiss announced during the past month that they will pay a special $2 dividend to shareholders on December 24th. This is a very positive sigh because on an enterprise value basis K-Swiss trades for less the 2 times my estimate of earnings a few years down the road. The CEO and CFO are two of the most candid managers out there, the decisions being made by the company show their philosophy of not thinking short term. I’m hoping the stock gets cheaper in the near term as I’m ready to buy a lot more. K-Swiss should easily be able to earn $60-90 million in net income when the economy improves. K-Swiss is currently trading for $400 million with nearly $300 million in cash. My estimate of intrinsic value $1250.5-$1478 million

Read my investment thesis on K-Swiss here

Freightcar America:

FCA is suffering from a downturn in the coal car cycle after the cycle peaked in 06 and customers over ordered. The poor economy also has a large negative effects on FCA. The 3rd quarter results were good but with the threat of a recession it is premature to say that the bottom of the coal car cycle has been reached. For the quarter sales were $238 million compared to $162 million in the same quarter last year and for the 9 months ended sales were $474 million compared to $680 last year. Net income declined to $7.4 million from $8.7 last year for the quarter. For the 9 months period the net loss was $3.7 million compared to a net income of $43 million last year. Orders during the quarter were 2329 compared to 1400 last year. Backlog at quarter end was 4401 units. FCA delivered 3082 railcars in the quarter compared to 2072 in the 3rd quarter last year. For the 9 months ended FCA delivered 6695 railcars compared to 8677 last year. FCA was hurt by material cost increases and large costs to close the Johnstown facility. To date the cost of closing the facility was $51 million and the remaining costs are small. FCA is trading for $258 million with $128 million in cash. My estimate of FCA’s normalized free cash flow is $36 million. FCA’s enterprise value is $130 million. My estimate of intrinsic value is $40-60 per share.

Read my last post on FCA here

American Eagle Outfitters

For the third quarter American Eagle had net income of 30 cents which includes a 9 cent writeoff of investments in auction rate securities. That compares to earnings of 45 cents last year. Sales were up 1%. Third quarter same store sale were down 7%. Operating margin was $95 million compared to $151 million or 12.6% vs. 20.3% in the same period last year. Results in the 3rd quarter 2008 include a $19.9 million impairment on the value of auction rate securities. Net income was $43 million vs. $99 million. The bright spot was AE Direct where sales increased 35% in the quarter. American Eagle has a market cap of $1.9 billion. Cash and investments total $616 million resulting in an enterprise value of $1.3 billion. Operating margins have averaged around 20% in the past compared to 12.6% in the last quarter. Even with operating margins around half of what they have averaged historically, American Eagle will be able to generate around $180 million in earnings a year. In addition American Eagle is an enduring brand with a lot of growth ahead with the new ventures such as aerie, Martin and Osa, AE Direct and 77 kids. A conservative estimate of intrinsic value is 2-3 times the current price.

Read my investment thesis American Eagle

Nicholas Financial

Nicholas Financial reported earnings of $792 thousand down from $2.6 million in the 3rd quarter last year. Revenue increased from $12.6 million to $13.5 million as the company continued to write new contacts. The new contracts are extremely profitable as NICK’s competitors retreat from the market. This pushed net finance receivables up to $210 million from $189 million in the quarter last year. The provision for credit losses was $5.1 million up from $1.6 last year in the quarter. This pushed the net portfolio yield down to 2.5%. The provision for credit losses is 9.86% so a 30% increase in the reserve would cause losses. The factor that most effects NICK is the unemployment rate. Management expects the charge off rate to worsen slightly in the fourth quarter. The strong point though is NICK’s reserve for credit losses that stands at over $23 million. This compares to charge offs over the last 6 months of $11 million. So the reserve is at a very healthy level. Nicholas Financial is trading for $25 million with $83 million in book value.

Read my investment thesis on Nicholas Financial

Pinnacle Airlines:

For the 3rd quarter Pinnacle reported revenue of $220 million vs. $203 for the same period last year. Operating margin improved to 9% from 7.3% last year. Operating income was $20 million compared to $15 million last year. Pinnacle has $64 million in cash and $127 million in auction rate securities. For the 9 month period operating income was $29 million vs. $43 million but the 2008 period contains a $13.8 million impairment on the value of the goodwill related to Colgan. Pinnacle currently has seven addition aircraft in it’s fleet that are being flown temporarily for Delta. Pinnacle has lead all regionals in operating performance for the past 22 out of 33 months. Colgan’s operations are beginning to turn around as its contracts with the government were rebid during the quarter. Management expects that Colgan will be profitable in 09. Also all the Q-400's are operational. Operationally Pinnacle is doing alright. The over supply of 50 seaters in operation is hurting them. They continue to generate a healthy amount of cash and a $30 million tax refund will be received in the first quarter.

Mohnish Pabrai began selling his stake in Pinnacle a few months back. No matter what, airlines are problem businesses. I now regret my investment in Pinnacle. My mistake was that I focused on PNCL as not really an airline company and I didn't consider the macro factors. I assumed that the contracts were solid. But when the customer is making all the money and the operator has the control, there is going to be problems. What Delta did was also caused by the over supply of 50 seaters in the market today. It doesn't make sense that the airlines would tolerate the regionals making so much money when economic conditions have caused them to be losing a ton on the other side of the deal. But the contracts do allow the parents to swap the 50 seaters for larger planes on a one for one basis. The result is yet to be seen but clearly Pinnacle has been impaired. But, PNCL has $200m in investments and 3rd quarter results were not bad. A healthy level of FCF is being generated. In my last post on Pinnacle I considered the worse case scenario and estimated a liquidation value. Given the price Pinnacle is trading at I’m holding.

Read my other posts on Pinnacle here