Barrons on Martin Whitman

Barron's had an article on Martin Whitman's Third Avenue Fund and here are some excerpts along with my thoughts (thanks to valueplays for the original mention)... Once you read a few interviews, it all starts to sound the same so I'll only be quoting some ideas I find interesting...


"We worry infinitely more about value than market outlook -- and since the near-term outlook stinks, no matter where you go, that is helping to create a lot more value for us to take advantage of," he observes.


This is kind of what seperates a value investor from a growth investor (strictly speaking there isn't much a difference between the two since the ideal investor is a mix of both.) Anyone buying any beaten-down company presently is not looking ahead to the near-term earnings. It's all about picking up something that is undervalued--and hopefully won't go bankrupt.

Whitman even mulled investing in Bear Stearns as the investment bank's turmoil worsened. "Why not?" he says now, shrugging. "If it was creditworthy, it was going to $100." He acknowledges, however, that his designated successor as manager of Third Avenue Value, Ian Lapey, "saved my ass on that one. He and I have to agree on any transaction in the fund, and he said 'No way!' on Bear Stearns because he couldn't make sense of what was on their books."


Bear Stearns would have clearly been a mistake. The problem with investment banks--in fact, many financial institutions these days--is that everything is opaque. As some have remarked, even the executives running the company don't know what is happening (it does beg the question why they are paid handsomely if they don't know what they are managing)...

Whitman pooh-poohs that analysis [i.e. bear view of MBIA]. When MBIA went out in search of new capital, Third Avenue ponied up a chunk of cash, to the tune of some 15% of the total $2.6 billion infusion into MBIA in February, at a price of about $12.15 a share. He figures the stock is worth closer to $35 -- at least. "Just because some of the securities are flawed doesn't mean the backer is in trouble," he maintains. "There are a whole bunch of amateurs out there running around and creating noise."


Comforting to an Ambac shareholder (me :) ) is the fact that Whitman is still pretty confident with his MBIA call. He has very little invested in Ambac so who knows what his views of Ambac are but it's good to see him sticking with his view. Of course, this doesn't mean that he will necessarily be right; but it does mean that someone with a focus on the balance sheet sees good things.

Do note that Whitman has lowered his expected value of MBIA. He thinks it is worth at least $35 but his first purchases were way above that. There is no doubt that MBIA's intrinsic value has dropped quite a bit. The huge shareholder dilution, along with greater-than-expected losses, pretty much ensures that.

Third Avenue Value's biggest holdings currently include stakes in St. Joe (JOE) and Forest City Enterprises (FCE.A), both of which were initiated back in July 1991. Whitman admits that St. Joe, once a forest-products company, has failed to live up to what he sees as its potential as a land company. "It's been very disappointing," he admits, but adds that he isn't prepared to walk away.


Whenever you run into stocks that someone owns, it is absolutely essential that you figure out when they bought the asset. You going out and buying St. Joe now is not the same thing as Whitman purchasing it back in 1991 and holding on to it. This doesn't mean that you shouldn't research it for a buy but it does mean that the situation is very different for you.

The same is true of long-time holding Toyota Industries (6201.Japan), which owns stakes in a number of operating businesses. Whitman's analysis showed that the stock had been trading at a 40%-to-50% discount to the value of its share of the earnings of those underlying businesses, in addition to a conservative multiple of its own operations. While the stock has appreciated more than 50% in yen over the 9½ years he has held it, the discount remains. "It's a frustration," he says. "It's a great business performer, but an unsatisfactory stock-market performer."


Toyota Industries illustrates a huge risk with investing in Japan (or any other shareholder unfriendly jurisdictions.) Whitman's analysis shows that Toyota Industries is trading 40% to 50% below intrinsic value (a lot of this is due to its cross-ownership of companies like Toyota Motors). But there is no sign that any of this value can be unlocked any time soon--if ever. I don't think there is any certainty that one can realize this "hidden value". Shareholder activism is almost non-existent in Japan and it is abhorred by the general public and government.

Currently, some investors might recoil from real-estate stocks such as Brookfield Asset Management or Forest City. Yet real-estate names dominate Third Avenue Value's list of holdings. Each offers the combination of an understandable business, strong finances and talented management.

"Bruce Flatt [CEO of Brookfield] is Canada's Warren Buffett," Whitman proclaims.


One thing to keep in mind is that Whitman tends to favour real estate.

Many of the more recent additions to the Third Avenue Value portfolio are of overseas stocks or domestic bonds rather than stocks. "We're not going to add [U.S.] common stocks unless the company has a strong balance sheet," Whitman says. "We'd prefer to own debt." That, he says, is increasingly possible: the credit market deep-freeze has created many value opportunities in securities like GMAC senior unsecured notes and surplus notes issued by MBIA.


Too bad small investors don't have access to the mononline insurer surplus notes, not that many would be considering it. I'm just a newbie but I concur with Whitman's views that there is probably more value in domestic bonds than stocks. Note that the credit crisis, as its name implies, started as a bond market phenomenon. A lot of the credit instruments are hit far worse than stocks. News articles over the months have talked about high quality corporate bonds trading as if defaults are going to be several factors higher than they were back in the early 2000's; municipal bonds trading with yields higher than Treasuries (that is extremely rare); auction-rate bonds and auction-rate preferred shares resetting to high (short-term) yields; junk bonds used in LBOs starting to collapse; and so forth. The stock market has it easy so far!

The comfort factors? The MBIA notes rank senior to other company securities, while GMAC notes are supported by a great pipeline of receivables, Barse points out.


The GMAC comment is interesting to me given that credit card defaults will likely worsen (especially if the economy slows down materially.) It'll be interesting to see how GMAC copes with all this.

Third Avenue Value's current portfolio is dominated by a group of Hong Kong-based real-estate companies, from Henderson Land (12.Hong Kong) and Hang Lung Group (10.Hong Kong) to Cheung Kong Holdings (1.Hong Kong). Says Whitman: "We went in there two years ago, and were able to buy these companies -- all of which have a big pipeline of property developments in China -- at big discounts."

CHINESE STOCKS HAVE PLUNGED THIS YEAR, but Whitman isn't perturbed. "Income-producing real estate is one of the businesses that is easiest to understand and value, and these are great long-term investments," he insists.

"Sure, you have political risk, Tibet, pollution, crazy Communists and all kinds of other risks," Whitman adds, but deciding whether to invest in China is all about the balance of probabilities. "Lots of things could go wrong -- but part of seizing value is being willing to look past the noise, no matter how loud it is."


I am risk tolerant (my Ambac investment, not to mention risky Bermuda insurer like Montpelier Re, indicates this) but I would be quite worried of China. I think investing in Hong Kong is better (that's actually what Whitman has done) but it's still questionable in my eyes.

You just never know what is going to happen over there. I was having a discussion with one of my co-workers and she was kind of pointing out how it's all murky over there. This goes on in most developing, semi-developed, and undeveloped countries, but the totalitarian government in China is more nationalistic than others. The legal system in particular is still stacked heavily in favour of the state.

I do think that China has the potential to become the next big economic power, but they need to get their legal system going... and provide more freedoms. People are more than happy to trip over themselves in order to generate profit but the lack of freedoms will come and bite them at some point. My comment isn't limited to China. Countries like Russia (czar Putin anyone?), India (one of the few countries where corruption is a part of life :( ), Dubai (what's freedom?), and so on.

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