Chris Bloomstran

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Amaya 25 Berkshire 15 HC2 Holdings 20 Orkla 12 Subsea 7 13 Tilly’s 22 Tucows 21 Exclusive New Content In the Investor Vantage Members Area (log in at www.InvestorVantage.com Inside this Issue

Editor’s Letter Chris Bloomstran Thompson Clark Investor Edge Value Revealed

Clearing up some Executing a value Searching for value in We discuss the im- Shining light on a concerns about the based investment unknown or unwanted portance of treating high quality business macro picture by dis- approach with invest- businesses, and find- investing as a leisure with a low-risk, high qualifying China as a ments in Orkla, Sub- ing it in HC2 Hold- activity and a couple return profile with reason for stock mar- sea 7, and Berkshire ings, Tucows, and of tricks to keep you catalysts in the online ket concerns. Hathaway. Tilly’s. focused on the long- gaming sector. term. PAGE 2 >> PAGE 3 >> PAGE 19>> PAGE 23>> PAGE 25>>

Copyright Warning: It is a violation to reproduce part or all of this publication for any purpose without written consent from InvestorVantage. Email [email protected] to request consent. © 2014-2015 by InvestorVantage. All rights reserved. InvestorVantage.com/termsofuse Investment Ideas For Intelligent Investors February 3, 2015 China...Does It Really Matter? “There’s too much emphasis on macroeconomics and not enough on microeconomics. I think this is wrong. It’s like trying to master medicine without knowing anatomy and chemistry.” Charlie Munger Since the recent correction, we’ve the air that China’s economy is actually go out on a limb and put a seen a bevy of reasons why the falling off a cliff. This just isn’t true! fairly high probability on China be- market is falling: interest rates China is actually growing. It may ing around for some time to come. might increase, China is falling off a not be growing at the rate it once Not only that — we’d even be will- cliff, here comes 2008 again. I was (10%). Instead it’s growing dis- ing to bet that they continue to thought it would be an important mally at 7%. I know, what a horrible grow well into the future as their discussion and, at the very least, economy. The U.S. may never lower class citizens make their way clear some things up regarding grow at 7% again and we’re com- to the middle class. China as a “reason” for the U.S. plaining about ONLY 7% growth. I If China doesn’t matter, why is market decline. understand that Chinese numbers the U.S. Stock Market in Media reporters are just doing aren’t the most trustworthy in the correction mode? their job, however, it causes them world, but, despite the conspiracy I don’t know (no one does). It could to ‘latch-on’ or try to find certain theorists, the truth probably lies be a whole host of reasons. Maybe, “things” to justify any recent move somewhere close to this number. the Chinese market selloff brought in the stock market. Essentially, to light that U.S. earnings peaked their job is to stay busy for the sake ON STAYING FOCUSED months ago, we were on the upper of being busy. If they can’t’ find a echelon of historical and absolute news story to talk about, they are “Know where you might valuation levels. In addition, the out of a job. They are forced to talk be in the cycle...Leave market hasn’t had seen a bear or write about something the sound bites and market since we bottomed in 2009. (regardless if there is a legitimate The market moves in cycles and news story or not). I have a simple headlines for the media. we’re probably closer to a de- reaction to almost any reason for a Focus on your business- leveraging cycle than not. The pull- broad market pull-back —- it es and their competitive back we are experiencing shouldn’t doesn’t matter! And it’s a waste of positions in their be a surprise to anyone. time to try to figure it out. An in- Should we be buying hand vestor’s time is better spent on markets.” over fist right now? things that can bring about tangible I don’t know (no one does). Re- results to your investing. Leave the But what if the Chinese slow- gardless, I am using this opportuni- sound bites and headlines for the down continues? ty to add to my favorite ideas slow- media. Know where you might be It doesn’t matter. Less than 1% of ly. We could easily go lower and I in the cycle and focus on your busi- our Gross National Product (GNP) hope it does so we can buy more of nesses and their competitive posi- is in sales to China. China is an our favorite businesses at bigger tions in their markets. The busi- incredibly small percentage of U.S. discounts to their intrinsic values. nesses will tell you what is going on exports, however it’s a much larger in the world and whether (or not) percentage for other counties. This Happy Labor Day! they are worthy of your investment. again puts the U.S. at a major ad- Lets get back to China being the vantage, not disadvantage. reason for the U.S market pullback. Obviously, if China disappeared Nearly every headline we’ve read tomorrow, it could be a big issue. lately has put a sense of panic in But alas, China is growing. We will

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 2 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Christopher P. Bloomstran — Semper Augustus Chris Bloomstran explains his evolution as an investor, his daily rituals, how he views Berk- shire Hathaway as his opportunity cost of capital, one of his biggest investing mistakes, and why he sees upside in Orkla, Subsea 7 and Berkshire Hathaway.

Chris Bloomstran, CFA, founded Semper Augustus in 1998. Chris employs a value-driven research methodology. He evaluates businesses just as a private investor would do when buying an entire company. Semper Augustus is a fundamental investor managing concentrated equity portfolios of well-run, well-capitalized businesses with share prices trading below their conservative appraisals of intrinsic value. They go where the value is. Currently, Chris is finding opportunity abroad, with two interesting investment ideas in Norway (Orkla and Subsea 7). He’s also finding value in Berk- shire Hathaway. All three companies featured are all exceptionally well capitalized and high quality businesses trading at discounts to their intrinsic values. Chris Bloomstran Tell us a little about Semper Augustus? for less than their unlevered cash on hand. He managed his family's capital for the next six decades, picking up new Chris Bloomstran: We founded Semper Augustus in companies like Wal-Mart along the way. I had the great late 1998. Massive bubbles in portions of the stock market pleasure of meeting Mr. Smith; he had heard I had serious were obvious, to us anyway, and we were acutely aware reservations about equity valuations and a building debt that launching an investment firm at that time might go bubble. We spent lots of time together discussing the mar- down as akin to building golf courses in 1929. Specific to kets, our respective thoughts on the businesses we each the late 1990's, a replay of the 1972-1973 Nifty Fifty had owned, and our respective approaches to investing capital. developed, with the bluest of the blue chips attracting huge We shared such a common outlook and philosophy that he capital flows while smaller company shares were being liq- ultimately hired me as the first outside advisor to the family, uidated. The ‘tiering’ within the market was profound. A turning over the reins to help intelligently liquidate the low- parallel and longer lasting bubble in TMT names basis, very overvalued portfolios and reinvest the proceeds (Technology, Media and Telecom) was underway as well. in the shares of smaller, better run businesses that were The era's insanity was ultimately marked by a hyperbolic getting cheaper as the market narrowed. He was getting mania for everything Internet. To subtly announce to the older and wanted someone who could help preserve and world that we "got it", that we recognized the folly around grow his family’s assets as he had done for so many years. us, we named the firm after the most highly valued of the With some tax efficient strategies we were able to cull out tulip bulbs in 1637 Holland. I had read Charles MacKay's businesses that had grown less attractive over the years, Extraordinary Popular Delusions and the Madness of many with inferior returns on capital and operating in staid Crowds years earlier and loved the historical and modern industries. Selling businesses like Kodak and the RBOC's day significance of the Tulipomania and other manias over for huge multiples to profits and buying smaller, well-run, time. It seemed the destined to fail Internet names would well-capitalized and growing companies was a no-brainer. go down as the Semper Augustus of the day. It was a great time for us. We managed to have cash at a It ultimately turned out to be a great time for our ap- time when many managers were facing ongoing redemp- proach. We had clients at the outset who had portfolios of tions for failing to keep up with the mania. By the market blue chips which had been purchased in the wake of the peak in 2000, we pegged fair value on the S&P 500 at just 1929-1932 stock market crash by a very smart individual. under 600 (market price was over 1500). The rest is histo- His is a great story in and of itself. This particular client liq- ry. We, like many value oriented investors, saw our portfoli- uidated his family's stock holdings in early 1928, as well as os significantly rise in value over the next couple years those of his brokerage clients willing listen to a twenty- while the markets tanked by 50% for the S&P and 80% for something investor preaching about a growing stock mar- the Naz. It was a privilege to spend lots of time with a great ket bubble. While painful to watch the market nearly double man until his passing in 2002. He was a saint of a man and over the next year and a half, he was ultimately right and an outstanding investor. Hearing about his experiences waded back in in 1932 and 1933 when England and the navigating a century of financial and world history was a U.S. went off the gold standard, buying companies like GE career and life highlight.

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 3 of 35 Investment Ideas For Intelligent Investors February 3, 2015 ON DAILY RITUALS: I try to offset the structure of running the firm with an unstructured research process! One thing I've done ritualistically is keep most mornings free of meetings or calls and read in depth...All the while I think I'm building cumulative knowledge that is required when opportunity presents itself. Has your view of investing evolved I obtained and read several years of whatever makes sense or comes up. over time? the company's annual reports and oth- It's very much an ADD approach but it er filings and was quick on my way to gives me the freedom to look at lots of CB: I think my view of investing has becoming a fundamental investor. things or to sit and work long hours, or evolved pretty similarly to that of many Over the next few years I read every a day, or a week or longer on an indus- value investors. It's funny to read Mr. book I could find on investing, working try or an individual business. My pro- Buffett's history of his evolution, begin- through the CU business library and cess undoubtedly drives Chad crazy. ning with things like candlestick chart- new releases at the Tattered Cover, He's cut in the public accountant / au- ing. I was a "serious" candlestick char- Denver's then great independent ditor cloth and organizes his schedule ter at the tender age of 20. I had bookstore. At a point I found Security and that of our staff by what seems the switched to the business school from Analysis and The Intelligent Investor, minute. Very task oriented. For that, mechanical engineering when I fell in which ultimately led me to Mr. Buffett. we run an extremely efficient and thor- love with reading the Wall Street Jour- Ultimately after several years of ough back office. nal. Differential equations didn't spark reading everything about investing I I try to offset the structure of running the same interest as the business pa- could get my hands on, I developed the firm with an unstructured research per. I really don't even remember why I what I guess you could call a relational process! One thing I've done ritualisti- started reading the Journal but it prob- perspective. After hours and hours of cally is keep the first part of most ably had to do with thinking I better thinking and reading, a light went on mornings free of meetings or calls and figure out how to invest the billions I and it made sense that everything in read in depth the Journal, the FT, the would make playing in the NFL, a an economy, in an industry and in a Times and skim the local sports page. I dream that never panned out thanks to company had to relate to each other have a couple news assimilation sites I a broken foot. I had a tiny surplus from and had proportional limits and read every morning as well. Jim Bian- a scholarship, which seemed like a bounds. It sounds simple and it is. At co's is terrific. I usually spend a few fortune at the time. I was heavy into the top, individual country GDP's com- minutes with Zero Hedge, which is a charting and had recently become a bined to make up global GDP. But little out there. From there I'm into my devotee of Bill O'Neil's CANSLIM deeper, corporate profits ranged over routine of working on whatever makes method. time and not only had to be some frac- sense or pops up. Most of my time be- A tip from the Heard on the Street tion of GDP but had to be a logical pro- yond the newspaper portion of the column sounded like easy money. I portion. The market value of a coun- morning is spent working on compa- remember doing "primary research", try's stock market had to relate to its nies and industries. My company spe- which involved looking at a series of GDP. Individual industries grew and cific reading runs the gamut from K's quarterly earnings per share numbers shrank as a percentage of the broad and Q's, quarterly earnings call tran- and noting the stock of interest had economy over time. I needed to know scripts and presentations. I utilize vari- "broken out" and was at a new high. All why. On a company level, the various ous industry specific filings and publi- signals were go. I walked into a small expense lines of an income statement cations. Value Line company pages, retail brokerage office in Boulder, had to make sense and tie out to the both the large cap and small cap found a broker willing to let me put half balance sheet and cash flows. The weekly editions, are an easy way to of my money in my little Norwegian oil world's financial components to me all keep up on lots of public companies shipping company called Nortankers. not only needed to fit together but did. I and industries and the competitive He advised against it - but still gladly developed a proportional sense of the landscape of the businesses we own. collected the commission which totaled components of an economy. I became These rituals build cumulative more than 10% of the purchase price. a better company and industry analyst knowledge that is required when op- As it turns out I never had to pay the for that and developed a pretty good portunity presents itself. back end of the commission. Shortly view of the macro along the way. after buying Nortankers, the Iraqi army Are you able to “shut-down” your rolled into Kuwait and commandeered What does your day normally look investing brain or separate it from two of the company's four VLCC's like (from beginning to end)? Do your normal life on the weekends? (Very Large Crude Carriers). The com- you have any daily rituals that help pany quickly failed. It was probably the you keep your investing edge? CB: My weekends are completely best thing to happen to me. Instead of different today than they were in the blaming the Journal, Saddam Hussein CB: Every day is different but there BC years, that is before children. We or the sophomoric CANSLIM system, I are certainly routines. I try not to keep have a high school freshman and a rolled up my sleeves and dug in for the a regimented daily plan but instead sixth grader. Both are very involved in why. keep the research day free to work on their respective sports and activities.

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 4 of 35 Investment Ideas For Intelligent Investors February 3, 2015 ON LESSONS LEARNED FROM SPORTS: I was fortunate and blessed to have the privilege of learning from a few men not the game of football but the values of team, commitment, hard work, overcoming adversity, bravery, honesty, sportsmanship and fun. I spent their younger years coaching a fresher on economics and common crust, and not only did I go down, but myriad of their teams and have thank- sense, Jeremy Grantham and his my epic fall created a huge pileup of at fully retired from coaching all but my group's work at GMO, Jeff Bronchick least twenty teammates. Nobody that son's football team. The kids sports are and Ben Claremon's letters at Cove fell with me thought it was very funny involved enough to allow for the invest- Street, as well as John Hussman's let- because it was on National TV. We ing brain shutdown you mention. But ters. Seth Klarman's letters are always laugh about it today. Thank goodness between games I still spend the majori- great when I see them. it was before YouTube! ty of most weekends reading. Chad is a voracious reader of busi- Over the years I have learned to ness and non fiction books. He reads Who are the people that inspire you compartmentalize my reading. I do something like 30 or 40 books a year. the most? And why? most of my company research at the I'm lucky in that he sends me his top office. I spend my weekends reading five or ten so that’s a nice filter there. CB: Of course you have to appreci- the candy, the fun publications I love to That's really the bulk of my weekend ate and be thankful for your parents. read but have to set aside for the reading. I never really formally segre- Growing up I saw little other than work, weekend so as to not distract from the gated the weekend candy from the and learned the importance of out- real business research. My weekend weekday company work, but that's the working everyone. We didn't really do reading list hasn't changed much for way it needed to evolve, lest the for- weekends. We did have our sports, but more than twenty years, though the mer intrude too much on the latter. I leisure activities weren't part of the leisurely Saturday morning reads over suppose when the progeny head out Bloomstran household. My step-father coffee and a bagel at the cafe are long into the real world I'll get my Saturday to this day runs a successful elevator gone. Barron's is a great read. The mornings back at the cafe... manufacturing and service company Journal launched a weekend edition on the west coast and still works all many years ago, so I'm now compelled What’s a little known secret about day, every day. He invented 24/7/365. to read that too. The weekday would you that no one knows? My memories of Christmas Day are have been enough, though Peggy opening presents by the tree while my Noonan has a column in the weekend CB: This has absolutely nothing to Dad manually wired electric control edition which is terrific. I skim the FT do with investing but it's funny, at least panels for elevator cabs at the dining weekend and the Sunday Times too. now it's funny. The most impressive room table. I'm also inspired by my Other general reads are the Econo- mascot in college sports is of course wife's compassion and also by the joy mist, which would be better as a Ralphie at the University of Colorado. with which my kids live life. monthly, and the National Review. The famous buffalo leads the football But beyond my family I will forever There are a handful of newsletters team onto Folsom Field for every be indebted to a handful of youth and which I have faithfully read forever and home game. She also travels to bowl high school football coaches that which are indispensable to keeping up. games, which sadly hasn't happened taught me the game of life. I was fortu- I love Marc Faber's Gloom, Boom and in years. But back in the day she was nate and blessed to have the privilege Doom Report, Jim Grant's Interest on the road every year, including 1989 of learning from a few men not just the Rate Observer, Jack Ciesielski's Ana- when we played Brigham Young in the game of football, but the values of lyst's Accounting Observer, and Fred Freedom Bowl in Anaheim. Southern team, commitment, hard work, over- Hickey's High Tech Strategist. Joe California has a funny kind of grass. coming adversity, bravery, honesty, Koster has a blog he calls Value In- Golf broadcasters call it kikuyu grass, sportsmanship and fun. Everything I vesting World which is wonderful. One known for being thick and spongy. learned from those guys carries over to of my favorite reads, including all of the Well, the end zones had been re- the investment arena. I mentioned that extras she has every couple weeks, is cently painted with each team's name, I coach youth football today. Giving Kate Welling's Welling on Wall Street. and the paint had hardened and was back in that way is as gratifying as an- I'm guessing your format is similar to like a shell on top of what must have ything I have done or accomplished in Kate's. Great in-depth interviews with been kikuyu. We had longer cleats to business and in investing. I'd tell any investors worth listening to are worth deal with the thick, spongy grass. You young analyst or investor, anybody every cent. I also try to keep up with can probably guess where this is head- driven and hard working for that mat- the periodic writings of various inves- ed. With a national TV audience, I ter, to at some point in life reflect on tors and strategists. The best are Van made sure I was near the front of the who helped mold you, to emulate Hoisington and Lacy Hunt's quarterly team following Ralphie onto the field. I those mentors and to find a way to letter at Hoisington Management, was of course the idiot who got his give back to the next generations in a which is an ongoing treatise and re- cleats caught in the black and gold way those role models did for you. I try

ON DUAL MARGIN OF SAFETY We place a huge premium on business durability and are extremely price conscious. We say our mantra revolves around a dual margin of safety, that of business quality and that of price. to give back in the investment commu- this gem. You also can't leave out the our businesses maintain net cash and nity for sure, by mentoring a handful of compilation of Mr. Buffett's Chairman's are not good clients of the investment business students. I've been involved letters - required reading in my opinion. bankers. We highly value quality man- with our local CFA Society here in St. I think a series of bound editions can agement and look for managers that Louis for a long time. I particularly love still be ordered on Berkshire's website. understand the underlying intrinsic val- working with college kids. They are also on the website as indi- ue of their businesses. Free cash re- vidual PDF's. turns on capital drive the bus. We read Security Analysis, The Intelligent A couple of other great business very little sell side research, instead Investor and even Margin of Safety books are Amity Shlaes' The Forgotten relying on a fundamental, bottom-up are very popular must reads for any Man and Arthur Herman's Freedom's process. investor. What are the top 3 books Forge. Both books span the Great De- The search for investment opportuni- people don’t talk about, but one’s pression through the period leading up ties is really just the byproduct of years that you would recommend to an to World War II and both are a testa- and years of reading. We have an idea investor? ment to the necessity of limited gov- of what a great business looks like and ernment. FDR's control administration have the patience to wait for the right CB: Well those are certainly the big- is examined for what it was and not as price. The downside of the price disci- gies. If you included Phil Fisher's Com- the revisionist's champion of the strong pline is that we often fail to own some mon Stocks and Uncommon Profits state. Both books are impossible to put businesses we have admired for years, you would have the Big Four! I can't down. for decades even. I guess those are count the number of copies of The In- the errors of omission. We've also sold telligent Investor I've given to clients, What is your philosophy and pro- some businesses just for price reasons friends and students. It's the best in- cess to investing? How do you that we regret selling and not buying vesting book not only for pros but even search for investment opportunities back. more so for the lay. Surely all of the and what are your criteria for invest- Wiley Investment Classics are worth ment? Is there a portion of your investment reading. The best of those are Phil process or philosophy that you Caret's The Art of Speculation, Gerald CB: The approach and the philoso- would consider unique? Loeb's The Battle for Investment Sur- phy are very much value driven, recog- vival and Fred Schwed's Where are nizing that growth is an integral part of CB: I don't know how unique it is the Customer's Yachts? But all of the the value equation. We place a huge but the thing that stands out to me is Wiley books are great. I mentioned premium on business durability and how uncomplicated we make the re- Mackay's book earlier. Another must are extremely price conscious. We say search process. I maintain an intrinsic read in the same vein is Charles Kin- our mantra revolves around a dual value estimate for each business we dleberger's Manias, Panics and Crash- margin of safety, that of business qual- own (or close to owning). That's where es. ity and that of price. Measuring the the heavy lifting and thinking comes in. One book that gets little mention out- intrinsic value of a business or asset is We normalize free cash returns on side of Austrian Economic circles, but what it's all about. We run concentrat- capital. It's an involved process. We is one of the best books ever written, is ed portfolios of generally not more than are very careful about cleaning up Henry Hazlitt's Economics in One Les- 30 names. We often concentrate heav- GAAP or IFRS earnings for things like son. It's up there in my opinion with ily at the top. Berkshire has been our aggressive pension accounting, mer- The Intelligent Investor. The book largest holding since our early 2000 ger accounting, write-offs and write- should be required reading for not only initial purchase. Subsequent well-timed downs and for non-cash compensa- anybody charged with shepherding purchases at nice discounts to fair val- tion. We think about whether deprecia- client capital but, perhaps more so, for ue, plus the growth of the business tion schedules make sense and try to any appointed Federal Reserve Direc- and naturally of the share price make get a realistic estimate of long-term tor, Fed regional bank president, staff that single holding quite large. normalized maintenance capex. employee, janitor, anybody in central Our turnover averages less than 20 Estimating the rate at which our busi- banking really, and certainly for any percent annually, though in 2008 it was nesses grow is hugely important. elected official headed to Washington manic, for us at least, at around 80 We're trying to get at organic growth or to a state capital. It's an easy read percent. We are wary of leverage and and how much growth comes from re- and is the best book on economics I've the balance sheets of our portfolio tained capital and how profitable that ever read. Like Graham's Classic, I've companies are in aggregate far superi- retained capital is over time. Share also given away countless copies of or to that of the broad market. Many of buybacks are measured against our

ON PRO FORMAS AND DCF MODELS: We don't maintain financial statement models but we spend countless hours thinking about them...I've found over the years the modelers adjust the inputs to suit their desired outcome. appraisal of the business and go to the By 2007, we were more large-cap ori- CB: That's a great question, and it quality of management. We reconcile ented, again, because that was where really gets to the heart of how we man- net profits to capital and then operating the value was. We have a sizable in- age capital. Nobody ever asks it. Eve- profits less maintenance capex to en- vestment today in Europe. Are we rything revolves around our appraisal terprise value. It's staggering how spreading ourselves too thin, reaching of fair value. I’ve already waxed on many professional investors talk about beyond a circle of competence? I'd say about our dual margin of safety ap- net income, earnings per share, quar- definitively no. Businesses are busi- proach, and the intrinsic value is really terly earnings misses, profit margins to nesses are businesses. The process I the price piece. Businesses that are sales and things like that but have no just described doesn't apply to compa- more complicated, more levered, more clue how much real capital is em- nies of specific size or where they hap- uncertain as to the permanence or du- ployed in the business or how levered pen to conduct business or have their rability of their franchise, or even those the equity of the business is. It's stag- headquarters. Medtronic isn't a differ- that we're not as fully up to speed on, gering, shocking, but I think it gives us ent company because they claim a simply get a lower intrinsic value until and our ilk a huge competitive ad- different home office. our understanding and comfort level vantage over time. I will say that if you look at a pages grows. Everything we do is generally The process requires hard work and long history of our transactions or on the conservative side. critical thinking to be sure, but it snapshots of our portfolios over time Once we've established an affinity for doesn't need to be complicated. It's far you will see certain industries far more a business and have determined our from it. We don't maintain financial represented than others. We've abso- appraisal of fair value, on principle we statement models but we spend count- lutely had more of our capital invested never pay more than our appraisal. less hours thinking about them. We in property casualty insurers and rein- There's no magic discount at which we don't run DCF models but we deeply surers over time than any other. Berk- start buying, but it's seldom more than understand the inputs of valuation. shire is obviously a big part of that but 90%. At 90% the upside slightly out- Terminal growth rates ten years out? we have maintained significant posi- weighs the downside. We invariably Give me a break. I've found over the tions in a number of other very well run start small, most of the time at one per- years the modelers adjust the inputs to insurers over the history of our firm. cent, sometimes at two, and, occasion- suit their desired outcome. Go back Most we have owned for years. The ally in special or unique situations, and look at Alice Schroeder's 1998 accounting and regulatory conventions sometimes far greater. Typically at one report on Berkshire. It was a joke. She are very unique and we have spent or two though. Then, and new clients had no clue how to value a business. years trying to master them and stay- have a hard time grasping this con- It's the simplicity of the approach but ing current. We do so from a user's cept, we hope the price declines ab- the focus on the right things I think that standpoint but our grasp here is pretty sent a deterioration in the fundamen- make the process here unique. It good, I think, particularly for a non- tals (and in our appraisal). doesn't require an army of analysts or operator. The P/C industry is com- We always want to make a small even a committee. It requires tons of prised of a handful of studs and lots of position in a high quality business larg- reading and thinking about the right duds. I think we've been fortunate to er and the most intelligent way of get- things. You have to ask the right ques- mostly own the studs. The beautiful ting there is to buy at a bigger dis- tions to get the right answers. thing about the industry is that it is count. The worst way to get there is to rarely expensive. Because the aggre- have a really attractive small position Do you have interest or expertise in gate winds up only being mediocre at accrete immediately to fair value or a particular industry that you would best, valuations across the swath wind above. Everyone loves a quick buck call your “circle of competence”? up generally being on the cheap side. but huge returns on small positions Or are you more of a generalist in At times they get dear and we've done don't move the needle much. search of value or market inefficien- a good job trimming our holdings at As a recent example, we had long cies? those times. wanted to own Precision Castparts, a fantastic business, and loved taking a CB: I've always said we're general- Describe your value discipline once one percent position about two months ists and we are. We don't limit our uni- you have arrived at an understand- ago, readied to increase the position verse by market cap, geographical ing of the Intrinsic Value of the busi- size as the price declined below our boundary or industry. At times, like the ness? Is there a certain discount $205 per share initial purchase. We late 1990's, we owned largely small from intrinsic value when you start rued and lamented Berkshire's an- and mid-cap domestic businesses be- to get interested? nounced takeout at $235 per share. It cause that was where the value was. was a nice return in a short period of

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 7 of 35 Investment Ideas For Intelligent Investors February 3, 2015 ON ZIRP EFFECTS ON THE STOCK MARKET ZIRP (Zero Interest Rate Policy) and an unwritten mandate to gear monetary policy to the level of t he stock market has necessitated a bending of historical valuation yardsticks but also higher allocation to stocks for otherwise balanced portfolios. time but way too little, way too soon. proached fair value and were generally that won't and can't grow sans increas- We do have certain unwritten guiding gone at intrinsic. With some portfolios ing debt levels. But expanding on this principles, (rules are too strict) about we use covered calls to help reduce tangent would require a conversation keeping positions in smaller business- and scale out of positions approaching into tomorrow at least. es or in less liquid securities on the fair value, just as we sell puts to initiate smaller size. In general, however, the or help add to positions. The conserva- What was the worst investment higher the quality of the business and tive selling of option premium around you've ever made? What happened, the greater the discount the more will- our intrinsic value philosophy lowers and how could you have kept it from ing we are to concentrate higher. Berk- risk, increases income and allows us to happening? shire is an extreme case in which we trade around our positions. But our have had on the order of a third of our somewhat rigid approach to trimming CB: That's a fun question! Really, all capital invested in the business. We and selling has necessarily been tem- of this talk about how wonderful our really use Berkshire as our cost of cap- pered of late thanks to the Bernank process is would have you believe ital. We measure business quality and and now the Bank of Yellen. we're devoid of mistake — Hardly. This upside/downside, effectively the dis- In the last few years we have al- business teaches humility. I mentioned count to fair value and the expected lowed some of our positions to trade that seventeen years into doing this as return over multiple horizons against north of our conservative appraisals. Semper Augustus we have pages and our long-term expected return in hold- Central bank policies and stimulus pages of transactions, despite pretty ing Berkshire shares. measures have thrown a monkey low turnover. On those pages you will Today, at the current price, we ex- wrench into the valuation engine. ZIRP find a number of mistakes. The num- pect to earn north of seven and a half (Zero Interest Rate Policy) and an un- ber is fortunately a fraction of the percent annually over a long horizon written mandate to gear monetary poli- "winners", but their existence is the holding Berkshire, so competing in- cy to the level of the stock market has nature of the beast. The great thing is vestments need to expectedly outpace not only necessitated a bending of his- that, I think due to the process and our that threshold. Berkshire's long-term torical valuation yardsticks, but also conservatism, nearly all of our mis- expected return, and that of any busi- higher allocation to stocks for other- takes have been small. The small ness we own, is totally dependent on wise balanced portfolios. Reducing handful of biggies not only jump out the current price. As example, Berk- position sizes at, say, 15 or 17 times but also have left an indelibly bad taste shire's shares are down about ten per- normalized free cash earnings, or at in the mouth that never goes away. cent this year. The business hasn't prices that exceed our adjusted share- Until the last couple years I would have seen a ten percent diminution in its holder’s return on capital (if you have a told you an ill-fated investment in Wil- intrinsic worth so our expected long- floor rate of return of 6%, then don’t liams Communications during the un- term return is very slightly greater than pay more than twice capital for a busi- winding of the tech bubble was far and it was on January 1. Conversely, Berk- ness earning 12% on capital), has away the worst investment I ever shire's shares were up 27% last year, meant bending the boundaries upward. made. Williams Communications was yet the fair value of the business grew We've allowed our investments in our a fiber network which had been spun nowhere near as fast. Thus, our ex- global, branded consumer businesses out of Williams Companies. Williams pected return from owning Berkshire in particular to trade at prices above had built and was still building a vast over the years was slightly lower at the what we consider normalized valua- fiber network with the advantage of end of 2014 than at the end of the prior tions. being able to lay the network alongside year. Ditto for the two prior years when But discipline is discipline and we their vast system of pipelines. Compet- the stock was up 33% in 2013 and have been downsizing these otherwise itors similarly used their railroad rights 17% in 2012. If only pension actuaries outstanding franchises at prices that of way. The energy business had pre- employed the same approach... make little sense in any environment viously sold their telco business, That ephemerally covers sizing on other than during hyper-inflationary WilTel, to LDDS, which eventually be- the buy side. On the flip side, we sell episodes. In fact, and this will get tan- came Worldcom. They retained a small or reduce position sizes accordingly gential, but the notion that sustained piece of the fiber network which they based on their intrinsic value, as well low interest rates warrant higher valua- set to expand and ultimately rebuild as on their expected upside/downside tions requires inspection. I'd argue the the WilTel business after a non- relative to other positions or opportuni- "terminal multiple", which would be the compete ran out. I attended an inves- ties. We also sell when we're wrong on price paid for the terminal growth rate tors meeting in Tampa with the top the fundamentals. We have classically from the DCF academicians, is lower, brass from both the energy business reduced position sizes as prices ap- way lower, like single digit, in a world and the fiber business at the time of

ON LEARNING FROM YOUR MISTAKES ...we're going to make mistakes, but not only should we learn from those mistakes, but, should use those mistakes to remind us to stay within our circle of competence. the IPO in 1999. We had a position in Leucadia and thus ultimately redeem- even. We're not throwing in the towel the energy business and that's really ing some value from the experience. at all, but with the position size greater why I was there. In the room were the The pain still stings, however. as a percent of capital than with the managers from the Janus Funds, all of But as I mentioned, the too long tale Williams fiasco, it's fair to say that in- them, keenly interested in the fiber of the Williams Communications spec- vesting in gold miners over the past business. That was a red flag. The ulation is probably not the worst. A few years has cost some real and rep- company had amassed something like gold position over the past three or utational capital. That said, even $7 billion in debt to build out the net- four years has been very expensive though they are down, the systemic work, and all of the math I did on the and, at least for now, is a real black risk we are trying to partially hedge company convinced me they would eye. I started buying gold mining remains front and center. We maintain never, ever produce a return on capital shares in the late 1990's at favorable the position and think it's the right thing of any kind. prices as gold was reaching its nadir to do. In retrospect, the common The IPO came at something like $40 near $250 an ounce. We made money thread between the permanent loss of per share, and the business had reve- and sold two of our three positions, capital in Williams Communications nues of about $2 billion and cash of $1 Barrick and Kinross almost perfectly in and the not permanent but not insignifi- billion to go with the $7 billion in debt. early 2008. We kept a position in New- cant unrealized loss in the golds is a We seriously laughed at the fools des- mont. As the globe's central banks deviation from the processes we just tined to lose their money — and they have gone back and forth with rounds talked about. We jumped the rails did. Later the next year the stock had and rounds of QE, we built a position away from buying great businesses at dropped to $4 a share, a 90 percent back into Kinross, added to the posi- good prices, in one case trying to haircut. That's when we decided to tion in Newmont, and more recently make a quick buck on a wasting asset, make a quick buck on a dead cat initiated a position in Goldcorp. We and in the other compromising busi- bounce in the wake of the bursting of have owned the miners as a proxy for ness quality and even price for what the tech bubble and joined with the gold. The gold position serves as a we believe to be a rational and neces- fools. We looked at the cash in the presumed hedge against central bank- sary hedge. I guess the upshot is we bank, $1 billion, next to the cost of ers gone wild. All the while we never know we're going to make mistakes, building out the network, and decided believed gold mining to be a great but not only should we learn from we had plenty of time to catch an up- business. those mistakes, but should use those ward spike and make a quick buck. I To justify owning the businesses you mistakes to remind us to stay within won't bore you with what I think was a have to do mental gymnastics to justify our circle of competence. massive fraud perpetrated at the paying for unknowable cash flows. hands of management. That's the nature of commodity busi- What was the best investment Needless to say, we endured a per- nesses. Ore grades are lower every you’ve ever made? What hap- manent loss of capital, selling our year. The low hanging fruit is long pened? stake for a small fraction of our cost. gone. The cost of production is never It's important to recognize that $4 to fixed, but rises at times faster than the CB: Thanks for changing the sub- zero is the same as $40 to zero in per- price of the underlying commodity. ject! A too easy answer would be a centage terms. As a footnote to the Management teams are anything but follow-on to your earlier question about story, Berkshire actually entered the superior. Add it up and it becomes great books. I think Mr. Buffett said picture later on behalf of the energy tough to justify a losing position over something similar already, but the re- business which had gotten upside what seems an eternity to clients. I turn on investment from my original down. Berkshire extended credit to really do believe there is no positive purchase of The Intelligent Investor is keep Williams Companies afloat at the endgame to the Keynesian experiment nearly infinite and is still compounding. usury rate of 34%, and as a kicker underway. Debt levels remain unser- A second lay-up would certainly be our picked up the Kern River Pipeline, now viceable under any normalized yield original purchase of a large position in a crown jewel in Berkshire's regulated curve. Weimar seems closer by the Berkshire in early 2000 at an average utility business. As a second footnote, day. cost of $43,750 per A share. But you're Leucadia purchased the assets of Wil- If we were running just our families' probably looking for something more liams Communications out of bankrupt- money I wouldn't sweat the losses in glamorous and sexy. A couple come to cy, and with the deal inherited the gold to date. But the percentage losses mind because they have similar char- company's vast tax loss carry for- are large enough, especially with Kin- acteristics to the purchase of the book wards. I take some solace, little really, ross, to wonder if there remains and to the 2000 purchase of Berkshire in having owned both Berkshire and enough upside to even see break - the best investments are those with

ON LOW RISK-HIGH RETURN INVESTMENTS: ..the best investments are those with no downside risk and huge upside reward. It's a combination that does exist from time to time and throws the classic risk reward efficient frontier curve as well as the efficient market hypothesis squarely on their respective academic pointy heads. no downside risk and huge upside re- least $2.00 per share, 90 percent of bought our Constellation position a ward. It's a combination that does exist which would come as dividend. We German news wire announced Con- from time to time and throws the clas- figured the stock would conservatively stellation was considering filing for sic risk reward efficient frontier curve trade at least at ten times. The risk free bankruptcy due to insolvency in a Tex- as well as the efficient market hypothe- trade played out as expected. We sold as merchant subsidiary. It was old sis squarely on their respective aca- all of our shares in less than two years news that somehow was just being demic pointy heads. in the low 20's and didn't regret selling mistakenly released. The stock started You may remember when several of early and leaving money on the table tanking. The Constellation sub already the big private equity guys launched as the stock briefly continued higher. In had Berkshire's $1 billion. The story mezzanine funds. Leon Black's Apollo the 20's the longer term risks, namely was old and wrong. I called Chad and Management was the first to bring a underperforming loans, outweighed asked how much cash we had. No ex- fund to market. Apollo Investment Cor- any further upside, and time works planation needed this time. We put the poration raised something like $900 against high-yield leverage. The stock majority of our cash to work in a matter million in an IPO in early 2004. The was around $6 the last time I looked. minutes at prices as low as $18, even fund priced at $15 per share, which The second low risk, high returner using the balance sheet of a partner- after underwriting fees netted $14.10 that comes to mind were a series of ship we managed to buy more shares. to the fund. Well, when the KKR's of investments made both on the coattails We had a big order out at $15 when the world saw how easily Apollo raised of Mr. Buffett but also on the other side the stock logically quickly recovered. nearly a billion, they and several others of Mr. Buffett during the financial crisis. We reduced the position way back in a quickly filed registration statements to We've never done much with utilities matter of hours. Time then passed and bring their own mezz funds. With sub- outside of Berkshire's investments in our plan was to allow the arb to run its stantial immediate competition poten- the industry. When Berkshire, through course or until something more attrac- tially coming, I think the syndicate that their MidAmerican business, offered to tive came along. That something came brought AINV public tried to dissuade bail out Constellation Energy in 2008 from within Constellation. The utility the competition from going public by by agreeing to acquire them, we did had engaged in a 50/50 joint venture allowing the price to not only trade be- some quick digging and determined with EDF, the huge French electric, to low the IPO price but below the netted that Berkshire, as has often been the develop some nuclear plants in Mary- value. We looked at the price below case, was getting a deal far below fair land and Virginia. EDF entered the mix $14.10, which obviously was all cash value. Constellation had an unregulat- with an offer to buy just under half of early on, and saw a virtually risk free ed wholesale merchant business in Constellation which valued the busi- opportunity. Apollo's plan was to build Texas that had gotten upside down in ness well above MidAmerican's agreed a two-to-one levered mezz portfolio their derivative book. Berkshire's offer price and closer to our $40 appraisal. over time, and to generate early re- to buy all of Constellation, which was Constellation's board claimed a fiduci- turns by parking cash in senior se- the big Baltimore electric, included an ary responsibility to consider the higher cured paper. We had no interest in immediate $1 billion dollar preferred offer, I suppose goading Mr. Buffett to being in the mezzanine lending busi- investment in the unregulated Texas bid higher. Anyone who knows or has ness long term, but given the timeline business to shore up the book and studied Mr. Buffett knows how much of reasonably putting the money to wind down the exposure. The work we he values a handshake. Constellation's work, the notion that new loans don't did on the company had Berkshire contemplation of the EDF bid certainly generally fail right away, and the over- buying Constellation for $26.50 per infuriated him. The upside to Berkshire arching fact that the $14.10 was all share, and our hastily put together fair was a termination clause which gave cash at the start, a short-to- value work up had fair value closer to them 10% ownership of Constellation, intermediate investment made sense. $40. In any event, with the wholesale plus a conversion of the $1 billion from The stock traded into the low $13's per book now backed by Berkshire, we the merchant business to a 14% se- share. I called Chad and asked him used a portion of our cash on hand to cured note, plus a several hundred how much cash we had. After explain- buy Constellation shares at $24 to just million dollars as a termination fee. ing that I meant ALL cash in ALL client long arb the upside to $26.50. Utility The Constellation stock sold off again accounts, we quickly added it up and acquisitions can take a long time to by about 20 percent on the news of the put most of that cash to work at about close but there was plenty of spread EDF offer, and of Berkshire’s exit, giv- $13.10, almost 90 cents on the dollar given overall market volatility during ing us an opportunity to pick up some of the cash in the bank at the fund. It the unfolding crisis. additional shares. It quickly recovered was reasonable to assume that given On a daily basis it seemed the market and we trimmed the position. After all, the anticipated leverage and yields at was reacting to news and rumor and it was 2008 and there were lots of the time that the earning power was at fact checking later. Not long after we things going on and places to

ON ORKLA’S VALUATION: Orkla's total intrinsic value is somewhere between NOK 70 and 87 per share. Said differently, you are paying about fair value for the BCG businesses and you get everything else for free. intelligently move money around. But currency should provide a huge pro- Foods, Orkla Confectionery and then the trade gets even better. Either spective tailwind for US investors and Snacks, Orkla Home and Personal and because he needed liquidity, which he gives you a call option of sorts on a Orkla Food Ingredients. Those busi- did, or out of petulance, which may be higher oil price over time. 710 million nesses will do about NOK 30 billion in correct, Mr. Buffett began liquidating shares float, with investor Chairman sales, which converts to about 3.6 bil- his now 10% position in Constellation. Stein Erik Hagen, through a family lion. The stock sold off again. We bought holding company and other related To give you an idea about how again. EDF had provided liquidity to parties, owning about 25% of the com- strong the dollar has been, at last replace Berkshire's $1 billion so we pany. At the current price the dividend year's exchange rate of NOK 6 to the reasoned a permanent loss of capital yield is north of 4%. Orkla reports in USD, dollar sales would be $5 billion. was nonexistent and the upside to the the Norwegian Krone using IAS/IFRS. The company's core business is large- EDF bid was substantial. So back we The Krone is really cheap and should ly conducted in Scandinavian curren- plowed into a bigger position. We be a wonderful currency long-term. cies so when I think and talk about closed 2008 with Constellation as one Norwegian debt to GDP is only 30%, Orkla's business I use Krone. Profit of our largest holdings and ultimately but net government debt is actually margins at the BCG businesses nor- sold our entire position in the mid-30's. negative. GDP is $500 billion and the malize at 10.4%, and were 9.1% at Oddly, Constellation ultimately merged country's has a sovereign wealth fund year-end. Return on capital for 2014 with Exelon after the EDF joint venture worth around $800 billion. Per capita was 15.2% for 2014 and normalize failed to move ahead with the nuclear GDP is the third highest in the world. closer to 17%. developments as originally planned Orkla was founded in 1654 as a py- At current margins the consumer and the joint venture partners rite miner. They went public in 1929 businesses will net NOK 3 billion on scrapped the merger. (great timing), started a separate in- their NOK 30 billion in sales. The cur- In both the case of Apollo Investment vestments portfolio in 1941, and had rent market cap of Orkla is NOK 60 and that of Constellation, a cumulative shed the mining operations by 1987. billion, which is about 20 times. Net body of knowledge, a proper definition They have been a conglomerate for a debt is a very modest NOK 6 billion. of risk, and a willingness and ability to handful of decades now, but are intelli- decisively move capital around allowed gently moving away from that struc- How did you arrive at the valuation the marriage of low or no risk to come ture. They bought newspapers and of the business? together with outsized upside reward. magazines in the 1980's and early If only these situations came along 1990's and sold those businesses to CB: On top of the BCG businesses, every day… Mecom in 2006. They bought pulp and Orkla has noncore, hidden value as- paper businesses, merged them with sets with a carrying value of NOK 16.4 We see you’re interested in a couple Borregaard in 1986 and spun that busi- billion. I peg fair value on those of NOK of Norwegian companies. Can you ness on the Oslo exchange in 2012. 25-28 billion. The BCG's alone are describe your investment thesis in Orkla found religion in 1995 and be- worth somewhere between NOK 46 Orkla ASA (ORKLY)? gan investing in food and consumer and 61 billion. With barely over 1 billion staples. They acquired Abba Seafood shares out the math is easy. Orkla's CB: Orkla ASA is what I'd call a dis- and Procardia Food, then acquired total intrinsic value is somewhere be- aggregating conglomerate unlocking Swedish brewer Pripps with Volvo. tween NOK 70 and 87 per share. Said asset value. With it you get a company They also bought Baltic Beverage differently, you are paying about fair narrowing its focus on four core brand- Holdings. They merged subs Norwe- value for the BCG businesses and you ed consumer goods (BCG) business- gian Ringnes and Pripps with Carls- get everything else for free. es, an improving margin structure and berg in 2000, retaining 40%. They sold Management has done a great job an attractive, undervalued currency. Carlsberg in 2004 at a great price. unlocking value and with ongoing re- The company is headquartered in Since then they have added numerous structuring of their noncore operations, Olso, Norway, trades on the Oslo Børs additional staples businesses. They joint ventures and associates. These as ORK and has a US ADR trading don't overpay and have a great track noncore subs are profitable, but due to OTC as ORKLY. Shares total just over record integrating new businesses. a series of write-down and restructur- one billion so at the current price of They bought Norwegian material coming charges their normalized profitabil- NOK 60 the market cap is NOK 60 bil- pany Elkem and Swedish Sapa group ity hasn't flowed through IAS/IFRS lion. The Norwegian Krone has been in 2005. numbers. crushed over the past year, falling from The four branded consumer goods 6 to the dollar to 8.3 to the dollar. The today consist of four segments - Orkla

INVESTMENT SPOTLIGHT: Orkla ASA (ORKLY)

Orkla ASA (PINK: ORKLY) Description: Provides branded consumer goods, aluminum solutions, materials, and financial investments.

Price $7.32 52-Week Range $6.22—9.33 Dividend Yield 4.43% Enterprise Value 8.4B

Basic Valuation: P/FCF: 28.54 Forward P/E 22.90 INVESTMENT SUMMARY EV/EBIT : 21.88 Shares in Orkla is approaching 52-weeks lows. Chris says, “Orkla's total

intrinsic value is somewhere between NOK 70 and 87 per share. Said Notable Owners: differently, you are paying about fair value for the BCG businesses and First Pacific Newton Inv you get everything else for free.” Artisan Partners Capfi Delen First Eagle Vanguard Sources: Company reports (10Ks, 10Qs), other public information

What would make you sell your po- years, masking substantial profitability end of the day, Orkla's markets are sition? and readying for what I think will be a mature. You'd rather have booming preliminary IPO as early as next Sep- populations, more mouths to feed. The CB: The best outcome for us would tember 1 in which Orkla and Norsk good news is Orkla's brands dominate to see the shares sell off precipitously. Hydro would each retain a third of the in their respective categories. I'd like our position to be larger with a company at first. The company recent- Also, I would have said oil at $100 lower basis! Once we are full it would ly did this with a smaller sub called was a big risk. Norway's GDP is 25% be great to see the shares accrete to Gränges. They did an IPO in Sweden dependent on energy. Hence the de- and above our appraisal of fair value and a secondary just this spring. Any cline in the currency. But oil in the where we could sell our holdings and severe economic downturn, think $40's and the Krone at 8.3 really be- move on to another dollar trading for about what happened to auto sales in come tailwinds in my opinion. Con- less than a buck. But I don't think that's 2008-09, could derail the timing or suc- sumer health sensitivities are a real what you are asking. You want to know cess of a potential sale. Orkla's share concern. Look at McDonalds and Kraft what could go wrong with the funda- of Sapa is carried at NOK 7.8 billion Foods. Orkla is heavy into processed mentals, and that's something we and I peg fair value at 1.5 book, 50 foods — the company gets it. They are spend lots of time thinking about with percent of sales and 7x EBITDA, which running fast to improve the health com- any investment we make. gets you NOK 11.5 billion. Another ponent across their food businesses. Probably the greatest concern I have longer-term concern is simply the ag- The CEO talks about things like lower- with Orkla over an intermediate hori- ing and slow growing population in ing the sodium content across the port- zon would be execution risk in selling Scandinavia. Norway has been in bet- folio but can also quantify the cost sav- off the investment portfolio. Their larg- ter shape. They have grown at 1.3% ings of doing so. Smaller and focused est investment is in Sapa, a 50% equi- for the past decade due to immigration. in today's case is better. We'd really ty method joint venture with Norsk Hy- Their fertility rate is only 1.8%. Sweden like to see the shares sell off a bunch. dro. The business is the largest global and Finland's population growth has It's only a decent sized position and I manufacturer of extruded aluminum been closer to 1% for a long time, but think the quality of the BCG business- profiles. CAFE and emissions stand- even there it's been on an upswing due es is high enough to be a big position ards drive demand. The company has to immigration. Trump probably has at the right price. But that's the story of been restructuring for about three something to say about that. At the my life today...

INVESTMENT SPOTLIGHT: Subsea 7 SA (SUBCY)

Qualcomm (OTCPK: SUBCY) Description: A seabed-to-surface engineering, construction & services con- tractor.

Price $8.56 52-Week Range $7.09—16.16 Dividend Yield 7.00% Enterprise Value 2.85B

Basic Valuation: P/FCF: 29.26 Forward P/E 21.19 INVESTMENT SUMMARY P/OCF: 3.70 Chris says, “with Subsea you need to think about everything in normal-

ized terms because of everything going on in the oil patch...On $500M in Notable Owners: normalized profits with 350M shares outstanding, you get $1.42 in free DNB Asset Vanguard cash flow profitability per share. With the current stock trading at only Templeton Global Blackrock ~$8.50 per share. A 10x multiple of $1.42 gives a stock trading at ~$14 Danske Capital per share and a 15x multiple gives us a stock trading at ~21.00.”

Sources: Company reports (10Ks, 10Qs), other public information I see you’re interested another Nor- world. Much like the Chairman at integrateds and with national oil com- wegian business, energy company Orkla, he has his family’s holding companies. The largest part of their busi- Subsea 7 (SUBCY). Can you de- pany largely invested in this business. ness is called SURF (Subsea, Umbili- scribe your investment thesis here? This is the crown jewel of his family’s cal, Risers, and Flow Lines). When you empire. And it’s a great business that think about where their projects are CB: We started buying it about a trolls around in the subsea energy located, it can be very harsh environ- year ago at a price well off its highs, space. ments. So they’ll also contract to go in but at a price well above current pric- Subsea really does seabed-to- and manage the infrastructure over the es. Everyone in the energy patch has surface EPIC (Engineering, Procure- life of the fields – make sure the flow just been crushed. We had a small ment, Installation, and Commissioning) lines are working, regular mainte- position initially, but, as is usually the work. They’re an engineering and con- nance, etc. case, we’ve added to the position as struction firm that effectively hooks up the stock has gotten cheaper. We have the subsea infrastructure of deep water How are you looking at valuation? a really nice average cost right now wells to topside production and gather- and we believe it’s a very interesting ing platforms. They have some shallow CB: Subsea has 350M shares out- story. I think it has some insulation rel- water assets and projects as well. standing. The current market cap is ative to many of the other more lev- They have a fleet of 39 vessels with about $2.8B. The ADR is trading ered players to the underlying com- five more under construction. Their around $8.50. The primary shares modity. They are a very interesting oil vessels are the most modern and tech- trade as SUBC on the Oslo at the mul- service company. nically advanced in the industry, where tiple of the currency conversion. With In conducting our research we its enablers – pipelay and heavy con- Subsea you need to think about every- learned that the Chairman is almost a struction vessels are superior. They thing in normalized terms because of Warren Buffettesque type guy named have the largest high-spec fleet in the cyclicality and certainly with everything Kristian Siem. He’s an excellent inves- industry. They also have 175 remote going on today in the oil patch. The tor and he’s been on the board of operated vessels. Their equipment entire sector has been disrupted by the Transocean Offshore (RIG). He’s allows them to contract on both a day decline in crude and the precipitous spent his entire career in the energy rate and a lump-sum basis with the big drop-off in tendering (front-end bid

ON USING BERKSHIRE AS THE OPPORTUNITY COST OF CAPITAL: We won’t put money in something else unless; you have great business quality, the price is right, and your expected return is at least what Berkshire is expected to return. process to contract with the integrated balance sheet because of recent fleet trading at ~$14 per share and a 15x and national energy companies). Over- upgrades (even with the allowance for multiple gives us a stock trading at all, business is just slower and all the another $1B write-off). So on a bal- ~21.00. If you’re constructive on your margins will be off. So if you have a ance sheet with $5.5B ($4.5B of which long-term outlook for oil, you can make view that oil prices will stabilize (not is very firm), they have maintenance a lot of money in Subsea 7. You also necessarily recover to $100), and if we capex of ~200M per year and depreci- get the huge currency tailwind pro- resume a normalized exploration cycle ation runs around ~$400-450M per spectively that you have with Orkla. for oil and gas, Subsea is one of three year. This gives a little more free cash We have a 3% position in the business companies that is best in its class. since the fleet is so new. As far as right now. However, there’s no one else in the income statement margin structure, I subsea industry that really competes in would normalize gross margins at From what I understand you’ve earnest with the three biggest players. 23%, 18% operating, 12% earnings been buying some Berkshire recent- Subsea 7, Technip and and Saipem before taxes, and 8-8.5% on a net ba- ly. It’s been a big position for you are the top three businesses in the sis. We probably won’t come anywhere for quite some time now. Can you sector and each have about equal close to those numbers this year, but I describe your investment thesis market share. believe they are viable over a 10-15 here? Let me start with the balance sheet year time horizon. because I think that’s where you get a In recent years, the company gener- CB: Yes, it is our biggest position margin of safety. You have total assets ated 19% gross, 13% operating, 8% by far. We had our original 5% position of $8.5B. The company wrote-off half pre-tax, and 5.5% after tax. That gives which we talked about in early 2000 of their goodwill last year. Goodwill us an idea of where they are right now. and it obviously worked out very well. was about $2.6B, now it’s about $1.3B. The company did $6.9B in sales last We’ve done a very good job of adding The goodwill is largely on the books year, which was a record and will be to that position absolutely and both for from a big merger between Subsea peak for some time. They’ll probably new clients and with new cash flows and Acergy back in 2011. They have generate $5-6B this year with the at, what we believe, are attractive dis- current assets now of ~$2B out of the downturn. On the low end of the range, counts to fair or intrinsic value. With ~$8.5B with cash at $373M and the I could see them generating $4.5-5B. that said, we’ve also trimmed the posi- company is almost running at net- At the $4.5-5B in sales, they’ll still pro- tion over the last few years with prices cash, or at least neutral. The only out- duce decent economic returns. I could approaching fair value. The last time standing term debt is converts ~$550. see net profits getting down to $200- the stock traded above fair value was You get total equity of ~$5.5B. Only 300M, depending on the utilization of back in 1998, since then it’s consist- ~$1.3B of which is now goodwill. their active fleet. With a market cap ently traded at a discount. Now it’s, What you have now with the assets today of $2.8B it looks really cheap on depending on the client, ~20-30% of on the books are some incredibly at- depressed numbers (potentially trough our capital. For newer clients in the last tractive vessels, as well as onshore earnings). However, if you normalize couple of years, we’ve only recently infrastructure (spoolbases and fabrica- the cycle, a 10% ROE on $5B in fixed been buying shares on this recent tion plants around the world, etc.). The assets gives us $500M in earnings downturn. We had trimmed it for longer asset value is very tangible and real. power. The stock today is trading less -term clients because it had become The company has been in front of the than 6x normalized earnings and it has such a large position and the shares downturn, quick to identify and sell or a great balance sheet. It is far better were closer to fair value than they had scrap several of their older and less capitalized than their two biggest com- been in some time. Almost all of our technically advanced vessels. There petitors. So they’ll have staying power clients have at least a 5% allocation to are nine to ten vessels slated for de- with the best fleet and engineers in the Berkshire now and we’re close to mak- commissioning right now. They recent- industry. ing it a 10% position for new clients. ly reduced headcount by 1,000, from At today’s price, you’re paying half Mr. Buffett certainly lays out how to 14,000 to 13,000, but have retained all book for a business that would pro- value Berkshire very well. It’s a con- 2,000 of their engineers. Their engi- duce an ROE of 9-10% on a normal- glomerate and there are a lot of mov- neers, along with their equipment and ized basis. On $500M in normalized ing parts, but if you do just a little bit of assets, give them their moat. And profits with 350M shares outstanding, work he tells you exactly how he looks once we get through this downturn we you get $1.42 in free cash flow profita- at it. We do individual work on as many have a company with best in class as- bility per share. With the current stock of the operating subsidiaries as we can sets that will earn excellent returns on trading at only ~$8.50 per share. A 10x get information on. Many file with vari- the carried value of the assets on the multiple on $1.42 gives you a stock ous regulators and there is a lot of

INVESTMENT SPOTLIGHT: BRK.B

Berkshire Hathaway (NYSE: BRK.B

Description: A holding company engag- es in a number of diverse business activities (insurance, energy, finance, etc.).

Price $132.10 52-Week Range $125.50—152.94 Dividend Yield N/A Enterprise Value $345.25B

Basic Valuation: INVESTMENT SUMMARY P/FCF: 17.89 Berkshire is a huge position for Chris and his firm (~20%). He says, EV/EBIT : 11.71 “Current prices are trading at 13x normalized earnings of $25B. That’s P/B: 1.32 an 8% return on capital at current prices...you can buy one of the best

businesses (if not the best) in the world at a market cap of $325B with a Notable Owners: put option underneath it and we think it’s worth $450-500B over time. Vanguard Group State Street Cascade Investment Bill Gates Sources: Company reports (10Ks, 10Qs), other public information information available not found in the two pieces of the business: insurance yond that it’s really that simple. SEC filings. In fact, we wish there was operations and everything else. (1) The reason we’ve made Berkshire more transparency as far as the oper- The insurance side has its own insur- such a big position, is that we believe ating subsidiaries go. As an example, ance accounting and regulatory char- Berkshire is our opportunity cost of we’d love to have a P&L, Balance acteristics, and each insurance compa- capital. We won’t put money in some- Sheet and Cash Flow Statement for ny within Berkshire is markedly differ- thing else unless; you have great busi- each sub once a year. Mr. Buffett gets ent from the others. But at the end of ness quality, the price is right, and your them monthly. Send a set down to St. the day, what you have in an insurance expected return is at least what Berk- Louis once a year! It’s not easy to de- operation are premiums coming in shire is expected to return. Buffett says termine how much capital each sub which are used to run the business, it himself, if you don’t want to be an carries year-to-year, for example, and the surplus of which are invested in active investor, just invest in the S&P we only get topside data on the larger various investment assets that are 500. Go buy a low-cost index fund to of the businesses within the company. used to pay current and future losses save yourself all the frictional cost and Mr. Buffett does breakout limited sum- and liabilities. To the extent you have expense. The cost savings and the mary financial data for what he consid- the ability to underwrite on a profitable lack of turnover will serve you well. ers the four key segments of Berk- basis over time, you’ll have the combi- We always compare the earnings shire, the groupings of the key insur- nation of what the investments will yield in our businesses to that of the ance businesses, the regulated rail make over time with the underwriting overall market. Today, the earnings and utility businesses, all of the busi- profits. That’s essentially it on the in- yield on the S&P is somewhere be- nesses in manufacturing, service and surance side of the business. (2) Then tween 3.7% and 5.8%, depending on retail, and a groping of a of finance and Mr. Buffett gives you the pre-tax earn- the degree to which you think profits leasing companies. It’s a very useful ings on the businesses not insurance are overstated on an accounting basis way of segregating and valuing the related. You apply whatever multiple and due to cyclicality. The earnings moving parts. But the detailed infor- you want to those pre-tax earnings and yield should be your expected return mation we gather and long for isn’t re- add the valuation of the insurance op- (unless you get further multiple and or quired to get a handle on how much erations. You can make a determina- margin expansion). We don’t use the the whole is worth – it really serves to tion as to long-term underwriting profit- S&P as our opportunity cost, because satisfy our analytical need. ability and the degree to which insur- we wouldn’t own the S&P. In terms of Mr. Buffett simply assumes there are ance float is really an asset, but be- deploying capital, we use Berkshire.

ON CURRENT MARKET ENVIRONMENT The financial markets are highly leveraged here in the short-term to the notion that the Federal Reserve has efficacy. I think Ben Graham would have likened Ben Bernanke and Janet Yellen to the voting machine...

And we use Berkshire because within the current price of Berkshire changes. moving target - it can go down. Howev- it you have a supremely diversified It’s always a moving target. Your oper, the risk-reward trade-off for this portfolio of high quality businesses – portunity set changes and we’ve re- quality of business is amazing. So why far better than the aggregate of the solved to the fact that we’re really com- wouldn’t you use it as your opportunity S&P. Within Berkshire, you generally fortable with Berkshire at current pric- cost of capital. have businesses that earn their cost of es. It gives us a very satisfactory ex- capital on a free cash basis. Overall, pected rate of return over time with What are The 3 Things an investor there isn’t a great deal of leverage with relatively low risk. We try to buy it should focus on the most to keep Berkshire either. I have no problem cheap and sell it dear. their edge or advantage over the paying more for a free cash flow At the current price the stock is trad- market? stream that’s not levered versus what I ing at 13x ballpark normalized earn- would pay for the same but levered ings of $25B. That’s a 7.7% earnings #1 - If you're not focused on what stream. That’s a valuation and invest- yield at current prices. Today, Berk- could go wrong then your focus is ing principle that’s lost on the vast ma- shire has a market cap of $325B and wrong. Manage risk – all risk! jority of investors. It’s the combination you have Mr. Buffett waiting to buy #2 - You're buying return on capital, of the diversification and the nature of back shares at 120% of book, which is which means properly understanding the free cash flow generating busi- at $300B. That’s essentially only 8% return and properly understanding cap- nesses within Berkshire that are large- down to where you have a known buy- ital. ly unlevered, which allows us to con- er with lots of cash willing to purchase #3 - Patience and a willingness to run centrate far more than what academi- shares on behalf of the shareholders at away from the herd allow you to own cians or consultants would say is pru- a published price and at a return in businesses, not pieces of paper. dent. And we’re not giving up the fact excess of 8%. So you can buy one of Bonus - The financial markets are that we’re active managers. We’re not the best businesses (if not the best) in highly leveraged here in the short-term throwing in the towel and handing over the world at a market cap of $325B to the notion that the Federal Reserve the capital management reigns to War- with an implied put option underneath has efficacy. I think Ben Graham would ren Buffett – not at all. Our expected it and we think it’s worth $450-500B have likened Ben Bernanke and Janet return on Berkshire changes every day right now. Book value is certainly a Yellen to the voting machine...

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 16 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Thompson Clark — MicroCap Millionaires Thompson Clark explains how he gains an edge by staying disciplined on his daily rituals, how he searches in the microcap space to uncover unknown investment opportunities, one of his biggest investing mistakes, and why he sees upside in HC2 Holdings, Tucows, and Tilly’s.

Thompson Clark is the editor of Agora Financial’s MicroCap Millionaires Let- ter. Microcaps are some of the smallest stocks in the market and normally trade for less than $1 per share. Because of this, Thompson is able to find investment opportunities that others ignore (or disregard altogether). Micro- caps are notorious for providing investors with asymmetric risk-return investment opportunities. Thompson graduated from Emory University with a Bachelor’s in Business Administration and is a CPA. Formerly, he was a Wall St. analyst at Sidoti & Co in New York where he focused on micro-cap companies. Prior to Wall Street, he worked as an international tax consultant for Deloitte. Today, Thompson is finding value in multi-conglomerates, technology, and retail sectors, most notably in such companies as HC2 Holdings (HCHC), Tucows (TCX), and Tilly’s (TLYS). The three businesses featured offer interesting growth profiles which could trade at multiples of their current price if Thompson Clark various catalysts come to fruition.

How did value investing start for you, and has your I was introduced to Chris Mayer (editor of 100x Club at Ag- view of investing evolved over time? ora). That led to where I am today at Agora where I was able to start my micro-cap focused letter. Thompson Clark: I’ve always had an interest in the stock market, but I didn’t always have a framework for in- What does your day look like from beginning to end? vesting. I remember when I was a young kid in the late 90s Do you have any daily rituals? telling my dad to buy a video game stock because I thought they had a great console. The stock subsequently exploded TC: I try to collect daily rituals of other successful peo- higher. He ended up selling to stock and buying me the ple. The book Daily Rituals by Mason Curry is a great book game console. I recommend. I get obsessive with developing daily rituals There was obviously no framework and I was mistaking sometimes. But they’re incredibly important. brains for an insane bull market. However, this got me in- Typically, I’m up around 6 or 7 in the morning. Then I’ll terested in this feed-back loop that you get in investing. In have coffee and spend the first hour or two reading. Many 2009, I got a copy of Snowball by Alice Schroeder. This of the successful people I’ve modeled over the years tend was my first introduction to Buffett and value investing. It to do their big mental work in the morning when they are was a great book and I remember reading it thinking, ‘this the freshest. After a couple hours of reading, I’ll make guy is fascinating.’ Over the next couple of years, I didn’t some breakfast and then head to my office. I’ll get to the really dive into value investing, as I was more focused on office around 8:30-9:00 when I’ll spend the first half an hour macro investing and economics. Essentially trying to figure skimming blogs, checking google alerts, SEC filings, and out why the whole global economy just collapsed. That’s some other feeds through Feedly. when I fell into the Austrian School of economics. I thought I normally have an idea that I’m working on at the mo- having a better understanding of the macro picture would ment, so I’ll have a 10-K on my desk. I read the 10-K and make you a better investor, but I found that not to be the work on that till about lunch time. Before I break for lunch, case. I should’ve listened to Buffett in that regard. I’ll print out research papers or an investment write up to However, I did read one book by an Austrian Economist read at lunch. After lunch, I’ll finish whatever I was working named Joe Calandro called Applied Value Investing. After on in the morning. reading the book and listening to one of his talks, it got me Around 2:00-3:00 I turn my computer off entirely and I’ll on my path to value investing. try to meditate for 10-20 minutes. It’s usually with head- Around that time, I landed a job at Sidoti & Co on the sell- phones which gives it more of a guided meditation. I find side covering micro-cap stocks. With my introduction to that this really refreshes me. Reading and focusing mental- Austrian Economics people in NY, where I lived at the time, ly all day can be very draining, so this really helps me

ON DAILY RITUALS: I try to collect daily rituals of other successful people...I get obsessive with developing daily rituals sometimes. But they’re incredibly important. recharge in the afternoon. After the read as much as they do has certainly how I approach investing. In the begin- meditation, I’ll get back to what I was inspired me. As you read more books ning, I started with statistically cheap working on in the early afternoon. and learn more about various compa- stocks. Now I spend the majority of my Sometimes I’ll return some phone nies, you’re knowledge continues to time on catalyst driven ideas. The core calls, listen to earnings calls or read compound long-term. That’s how I of what I write about in my letter are transcripts. And that takes us to the think about spending my time – it’s the microcaps that have an event or cata- end of the work day around 5:00-5:30. quest to compound knowledge. The lyst that will close the gap between I play a lot of squash, so I’ll head to the fact that Buffett, in his prime, was read- price and value. gym after work. ing 500+ pages per day is astonishing. Most of my screening comes from The rest of the evening is reading, SEC filings. Every 13D that’s filed we relaxing, and dinner before I usually go What are the top 3 book people take a look at. And there are a lot of to bed around 10:30pm. don’t talk about, but one’s that you activists in the microcap space right would recommend to an investor? now. Are you able to “shut-down” your investing brain on the weekend or TC: The Power of Now by Eckhart Do you consider your investment separate it from your normal life? Tolle really helped me think about process or philosophy unique? meditation and focus. Along with that, TC: I don’t know if I have an obses- I’ve recently read The Rise of Super- TC: Typically when people think sive personality or if I’m just passion- man by Steven Kolter. It talks about about microcap investing, they’re just ate. On the weekends, I don’t really how athletes get into a state of flow looking for dirt cheap stocks that no shut down. I’m usually thinking about when they are at their peak perfor- one cares about. I like that, but I’ve what I was working on Friday and mance. Value investing isn’t an ex- also seen situations when you can buy what’s coming up in the week ahead. If treme sport by any stretch of the imagi- a cheap stock and it just stays cheap I’m lucky, I’ll come into the office for a nation, but the flow concept is im- forever (especially if it’s a microcap). A couple of hours and continue reading portant to understand and think about. requirement of mine is to always have an annual report or a book. I would say A more investing related book would a catalyst that will close the gap be- that on the weekends in particular, I be The Davis Dynasty by John Roth- tween price and intrinsic value. spend more time reading books than child. It’s about Shelby Davis and his annual reports or investment research. whole investing career, which is in- Do you consider yourself more of a credibly interesting. He was one of the generalist in search of value or do Who are the people that inspire you first to see the real value in insurance you focus on particular sectors that the most and why? companies. During his time people define your ‘circle of competence’? didn’t understand or value them cor- TC: I read this profile on CNBC of rectly, but he understood them well. He TC: When I was on the sell-side of Lee Cooperman (Omega Advisors) backed up the truck on a lot of mis- the industry, I did focus on technology from 2013. He talks a lot about his dai- priced insurance companies. companies. However, now I would def- ly routine. He lives in New Jersey and initely consider myself more of a gen- works in Manhattan. He gets up every What is your philosophy and pro- eralist. I would say that after years of day at 5:00am and he’s in the office by cess to investing? research that I’ve become a big fan of 6:30am. And then he basically works subscription based companies. The non-stop till 11:00pm at night. That TC: My philosophy is flexible. I re- accounting can be weird and adjust- inspires me! That level of passion is member a 2006 write up with Larry ments need to be made to figure out something I strive for on a daily basis. Robbins (Glenview) in Value Investor what the stock is worth. It may not be The whole routine he has and his suc- Insight. He discussed that every year profitable right now because they’re cess as an investor is probably a func- his firm tries to learn a new strategy. plowing money through SG&A to buy tion of how great his routine is on a So one year they’ll try merger- more subscribers. The market can daily basis. arbitrage, then distressed debt, and sometimes miss these kind of opportu- Also, Buffett and Munger’s ability to then event-driven situation. So that’s nities (especially with microcaps).

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 18 of 35 Investment Ideas For Intelligent Investors February 3, 2015 ON READING EVERYDAY: Everyone says it but not everyone does it. You have to read a lot...If you love it, it’s great. If you don’t, then it’s going to be tough and you should probably be in different business. Stick to a process and continue to refine it over time. Describe your value discipline once What was the best investment Mayer’s letter (100x Club). One of the you have arrived at an understand- you’ve ever made? picks I contributed to his letter was ing of the intrinsic value of the busi- HC2 Holdings (HCHC). HC2 is run by ness? TC: Aside from buying 10 bitcoins a hedge fund manager who’s had a at $10 bitcoins a long time ago…The very controversial, yet very successful TC: What I try to do in my letter, un- best personal investment I’ve made career, Phil Falcone. He’s the CEO der reasonable circumstances, I try to was a small company called Air T Inc. and Chairman of the Board. He takes a explain how a stock can double. I like (AIRT). I found out about the company no cash salary – only stock. He’s using for that to take place in 2-3 years after they filed a 13D on a company I HC2 as a holding company for his in- (obviously the sooner the better). Gen- was researching. So I decided to dig in vestments. erally, I make an analytical case for and start trying to figure out what was The company has two core busi- why a stock has 100% or more upside going on with this company. The stock nesses that generate all of the revenue to reach intrinsic value. looked really cheap and it was run by and EBITDA, Schuff International and an activist investor named Nick Swen- Global Marine Systems. Schuff is basi- What was the worst investment son. I think his firm owns 20% or more cally a specialized steel fabrication you’ve ever made? of Air T. This was about a year ago. business. They’re involved in building Before I invested in the company I the Apple Headquarters in California, TC: It was during 2011 when a lot of needed to meet the capital allocator. amongst a plethora of other things. the reverse-mergers were going on in So I went to the shareholder meeting Global Marine is a business that’s the market with the Chinese fraud in August of 2014. I met Nick and real- been around since the 1850s. They companies exploding. I thought I was ly liked what I heard. A few months actually installed the first subsea cable smart and found the perfect one that later, his firm came out as an activist across the Atlantic Ocean. was going to zero. against Biglari Holdings (BH). They Today they’re involved in installing At this point I had no framework for own Steak-n-Shake and it’s owned by and maintaining underwater fiber optic investing. But I loaded up on put op- a controversial investor named Sardar cable for telecom businesses. They will tions in a ‘sketchy’ Chinese company Biglari. As a way to retaliate for Air T keep their ships in port until a mainte- and they expired before the company going after Biglari Holdings, Biglari in- nance call and go fix an issue. Even if went to zero. I haven’t shorted any- discriminately bought Air T to the effect there are no issues, they still get paid. thing since then. It was a lesson that of the business doubling in 2-3 weeks. So it’s a very interesting business. shorting isn’t as simple as saying, So I thank Sardar for that. Along with the two core cash genera- “Hey, this stock is overvalued.” You With the letter, Tucows Inc (TCX) tors, HC2 has a bunch of other need to factor in how much you’re pay- was one of our more successful invest- “venture capital” type of investments. ing to take that position (your cost to ments. I brought it up to readers of the It’s a wide range of businesses from borrow). letter in the spring of 2014. I told them companies that cure osteoporosis to With the letter, the biggest mistake at one point, after it had pulled back a sports betting. They just bought a long- was recommending an overleveraged little, to make it a large position. We term care insurance business at a fire gym company located in the Northeast were up about 100% at one point, but sale price. U.S. I probably needed to conduct a it’s about 85% now in a little over a little more work understanding the dy- year. Describe how you look at the valua- namics of the business. And really un- tion of the business? derstanding the capital structure. I see you like HC2 Holdings right A business in a turnaround phase now. With shares down more than TC: There are many pieces to the with a bad balance sheet does not 40% off their highs in April, what is story. The way I look at it is if you pay have time on their side. Debt payments your investment thesis? 6x EBITDA for Schuff and Global Ma- and other events can cripple a compa- rine, you get the rest of venture invest- ny. This business deteriorated and the TC: Along with writing my main ments for free essentially. Today the stock didn’t work out well. newsletter (MicroCap Millionaires), I stock is ~$7 per share. I look at the also contribute as an analyst to Chris valuation here where if you just include

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 19 of 35 Investment Ideas For Intelligent Investors February 3, 2015 the other venture investments at cost, so I’m not too concerned about that all the big four carriers (Sprint, Verizon, it’s a $14 stock versus today ~$7. It though. ATT, T-Mobile) have to give a piece of seems like an interesting situation. Phil their spectrum to wholesalers like Met- Falcone is involved and there are nu- We talked about Tucows a bit al- ro PCS and Virgin. merous smart shareholders that own ready. Shares have hung in well Ting is another one of the wholesal- the stock in size. compared to the rest of the market, ers and they run on the Sprint and T- what is your investment thesis on Mobile networks. It’s a pay-as-you-go What situation or events would Tucows? mobile phone service that has grown make you sell your position in HC2 to 178,000 devices on their network Holdings? TC: Tucows (TCX) is a ~$300M mar- (end of 2nd quarter). I use the service ket cap Canadian company. They myself and they charge you per mi- TC: Phil has made some aggressive started off as a domain registration nute, per text, and per megabyte. bets that haven’t done well to date. If I company. Anytime you registered a So if you really wanted to have the were to see him put all of his eggs in domain you might go through one of lowest possible phone bill you could one basket I’d be concerned. However, their registrars. It’s a commodity busi- have it instead of signing up for the “all right now they’re involved in a dozen ness now, but the way they got really you can eat” plans that the big four different companies. So I don’t see that good at this business was the custom- carriers offer. I think they’ve done a as a risk yet. er service. It sounds cliché, but they fantastic job growing this business The two core businesses are cyclical, were very good at taking care of their from zero to 178,000 devices. Which is so I would be concerned if we saw a customers. Now they’ve been able to still very small in the grand scheme of downturn in construction — earnings leverage that customer service exper- things. Their churn rate has been really would take a hit. HC2 as a whole does tise to start a new business called low, which is surprising because there have a fair amount of debt, so that Ting. Ting is a completely separate are no contracts. This goes to show could scare me off a little too. Phil is business and operates as a mobile their overall value-add proposition to incentivized not to hurt shareholders, phone carrier. The FCC requires that the customer.

INVESTMENT SPOTLIGHT: HC2 Holdings (HCHC)

HC2 Holdings (NYSE: HCHC)

Description: A holding company for various operating subsidiaries mainly in the U.S and U.K.

Price $7.35 52-Week Range $3.93—13.28 Dividend Yield N/A Enterprise Value $569.58B

Basic Valuation: Forward P/E: 4.84 P/FCF: 0.21

Notable Owners: INVESTMENT SUMMARY Paul Tudor Jones TETON Thompson says, “if you pay 6x EBITDA for Schuff and Global Ma- Mario Gabelli Vanguard rine, you get the rest of venture investments for free essentially. To- Chareles Brandes Eaton Vance day the stock is ~$7 per share. I look at the valuation here where if you just include the other venture investments at cost, it’s a $14 WHALEROCK POINT Hudson Bay stock versus today ~$7.

Sources: Company reports (10Ks, 10Qs), other public information

The third leg of this stool is the offering phone market. If they get to 1 million Tilly’s is a teen retailer that is primarily of fiber to the home for internet. They devices, it’s only 0.10% of the whole concentrated in California. You can bought a little company in Virginia device market. So it’s not a huge mar- think of it as a Pac-Sun or Zumiez. It called Blueridge Internet Works. ket, yet it would be a massive driver of looks like they’ll end the year with 200 They’re basically going to apply the earnings for the company. stores. It’s an interesting business. Ting model to bring 1GB internet to They’ve done eight Dutch tender of- If you think about teen retailers, you your home. So you’ll have 1GB up and fers and that’s something you don’t can usually group them into two buck- down of internet at a very competitive see every day. It’s very rare. I think if ets: (1) the ‘Abercrombies’ and price. They’ve only hit one or two cities there was a second edition of the Out- ‘Aeropostales’. They are more of a so far and plan to add many more. siders that the CEO Elliot Noss would fashion company because they have to be included. make a bet on what teens want for the Can you describe how you arrived You have to make some assump- next season. And if they hit, they hit it at the valuation of the business? tions as to where the business is go- big. But if they miss, they have to liqui- ing, but I believe it’s a great business date all the inventory and it becomes a TC: They have a net cash position. If and it’s something people should look huge mess. (2) In the case of Tilly’s, you believe the 2015 guidance, which I at. they don’t really have their own brand. think they will exceed, then they're They’re a brand aggregator. They’re trading a little under 11x EBITDA. It’s Tily’s has really taken a hit of late as selling Vans, QuickSilver, and lots of not crazy cheap, but I think there is a it sits more than 50% off its highs in other surf and sports related brands. long runway for growth within the mo- April. What is your investment the- They’ve done a great job of growing bile and fiber business. On top of that, sis here? this business from no stores to 225. you still have the cash cow in the do- The founder and CEO is still involved main registry business. They still have TC: I found out about Tilly’s (TLYS) and owns a big portion of the compa- such a small fraction of the U.S. cell from reading Value Investor Insight. ny.

INVESTMENT SPOTLIGHT: Tucows (TCX)

Tucows Inc. (NAS: TCX)

Description: Provides simple useful services that help people unlock the power of the internet.

Price $25.84 52-Week Range $13.50—32.23 Dividend Yield N/A Enterprise Value $268.98B

Basic Valuation: Forward P/E: 30.21 P/FCF: 30.27 EV/EBIT: 20.33

INVESTMENT SUMMARY Tucows is hovering around $25 per share. Thompson says, “They Notable Owners: have a net cash position. If you believe the 2015 guidance, which I Renaissance Tech Driehaus think they will exceed, then they're trading a little under 11x EBITDA. Osmium Bogle It’s not crazy cheap, but I think there is a long runway for growth with- IsZo Capital Marathon in the mobile and fiber business...They still have such a small fraction Bridgeway Capital O’Shaughnessy of the U.S. cell phone market. If they get to 1 million devices, it’s only 0.10% of the whole device market.

Sources: Company reports (10Ks, 10Qs), other public information

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 21 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Describe how you arrived at the val- of $15 per share. don’t, then it’s going to be tough and uation of the business and what cat- In my initial recommendation, I men- you should probably be in different alysts you see to help close the gap tion that a catalyst on the horizon could business. Stick to a process and con- between price and intrinsic value? potentially be the bankruptcy of tinue to refine it over time. PacSun (PSUN). PacSun took on too TC: The stock is trading at ~$8 per much debt and started selling their #2 Invest Through The Wind- share, which is less than 4x trailing own labels instead of the popular shield...Not the Rearview Mirror — You EBITDA. They have a net cash posi- brand names. This was a major mis- have to think ahead and figure out tion. It’s certainly interesting on a rela- take on their part and they’re paying where things are going, not where tive valuation basis. for it right now. Tilly’s could step in and they’ve been. I understand the argu- The hope is they can grow their store increase store count if PacSun were to ment for mean reversion, but some- base at a reasonable rate. They have close up their stores. times that’s not the case. You need to a keen focus on ROI for each store. So separate when that the case and when they don’t build stores for the sake of What are The 3 Things an investor it’s not. building stores and growing. They should focus on the most to pro- have to hit a hurdle ROI. duce out-sized investment returns #3 Don’t Get Obsessed with Numbers Once they get to a certain store over the long-term? and Analytics — You have to look at count, I think you’ll see a multiple ex- the behavioral side as well through the pansion. Comparable peers trade at #1 Read and Read Widely — Every- insider ownership and their incentives. 6.5x EBITDA and the stock today is one says it, but not everyone does it. It’s so important and it’s very difficult to trading at 4x EBITDA. So if they were You have to read a lot. Friends will ask do because you can’t easily screen for to get the peer valuation of 6.5x what I do all day and I tell them I read it or quantify it. You can’t put it in a EBITDA, I think the stock’s worth north all day. If you love it, it’s great. If you model and have it spit out the answer.

INVESTMENT SPOTLIGHT: Tilly’s (TLYS)

Tilly’s Inc. (NYSE: TLYS)

Description: Operates a chain of special- ty retail stores featuring causal clothing, footwear, and accessories for teens and young adults.

Price $8.02 52-Week Range $6.65—16.99 Dividend Yield N/A Enterprise Value $149.73B

Basic Valuation: Forward P/E: 18.45 P/FCF: 9.22 EV/EBIT: 6.20

Notable Shareholders: INVESTMENT SUMMARY Frontier Capital Greenblatt Shares have dropped to 52-week lows. Thompson believes there could Emerald Fund AST Small Cap be an opportunity here at current levels. He says, “Comparable peers Russell Frank State Street trade at 6.5x EBITDA and the stock today is trading at 4x EBITDA. So if they were to get the peer valuation of 6.5x EBITDA, I think the stock’s NS Advisors worth north of $15 per share.

Sources: Company reports (10Ks, 10Qs), other public information

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 22 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Investing As A Leisure Activity…? “…If you can buy a few great companies, then you can sit on your ass. That’s a good thing.” Charlie Munger

There’s no escape!!! set of parameters in order to make the being busy. Doing nothing is a con- The thought of investing is constantly grade, and therefore, may be few and science choice too. You need to resist on the minds of most individuals as far between. the need to trade or transact every they search for ways to boost their quarter just to make sure you're look- wealth. The issue that most investors On Leisure Investing: ing busy. Instead, it is better to simply face is that they don’t know how to ap- The problem is lead a relaxed and leisurely lifestyle proach it properly. When it comes to while maintaining your watch-list until investing in the stock market, most activity doesn’t mean that perfect opportunity comes along. individuals watch the movement of the numbers and the data with a feverish success. In fact, it’s Always Have a Checklist regularity. Many see their efforts in the quite the opposite... Over the years, we have learned stock market as a business that must many valuable lessons on how to find be monitored regularly, “tick-by-tick.” As a leisure investor, you want to the best possible investment options. They constantly watch for perceived understand how a potential business However, we did not come to that “tell-tale” signs of when they should actually fits in relation to the rest of the knowledge without making a few mis- buy or sell, in hopes of gaining out- world or an industry. Looking for this takes along the way. Even after you've sized returns through activity. unique perspective could give you done all the research and analyzed The problem is activity doesn’t mean some insight that others may not be every possible angle you can think of, success. In fact, it’s quite the opposite. able to glean from just studying a com- things can still turn sour. Lessons are There's no question that the trickiest pany's specific fundamentals. When to be learned at every turn, and those part of investing is choosing the right you're analyzing a particular stock you that lead to losses will remain with you approach and the right system. Even want to make sure that it has some for many years. the most seasoned of investors will, at type of moat (sustainable competitive The trick is to take those lessons and some point, find that their investment advantage) that will make it difficult, if avoid repeating them. You can do this choices will not perform as anticipated. not impossible, for competitors to by maintaining a checklist that will This can cause them to become more swoop in and take over a percentage eliminate the risk of forgetting to check active in hopes of looking busy or of the market share. You're looking for for certain circumstances that could providing value. a deep moat that continues to get lead you down the wrong path. When Investing is not a static exercise. deeper as the business continues to you study and use your list, you will be Achieving investment success isn’t just grow. This will allow your investment to able to compare it to other factors in about making one right choice. Not compound in a leisurely manner. your portfolio and determine what risk only do you need to make the right Great stock opportunities do not factors you would be exposed to. Real- choice in your investments, you also come along every day, so you have to istically, any business you choose will need to exercise such qualities as pa- keep on the lookout for them and add have some element of risk, but it will tience and composure. So successful them to your watch-list when they do be up to you to decide what percent- investing is not only choosing the right come along. Sometimes it may take age of risk you're willing to take based investment, but also waiting for the years for that right pitch to come along, on your checklist and other available right investment and holding on to it. so patience is key when it comes to opportunities. Instead of being on a constant search making the right decision. This phe- Investing in the stock market is not for stocks that may or may not produce nomenon always reminds me of a for the faint of heart. It can be quite results, an investor should, instead, quote by the great algebraist Jacobi frightening to put your hard-earned patiently wait for that one stock that Pascal, "All man's miseries stem from money at risk. However, you'll soon promises to deliver profitable results his inability to sit in a room alone and realize that taking some very basic over its lifetime. These investment op- do nothing." steps can yield some very positive re- portunities must meet a very specific In short, don’t be busy for the sake of sults. There is no need to put all your

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 23 of 35 Investment Ideas For Intelligent Investors February 3, 2015 money into your investment ideas all at you will have less information. Be- Seth Klarman, manager of $24 billion once. It's not complicated, but by ap- tween the two options, I prefer invest- Baupost Group, says “If you play near plying simple logical measures, your ing with less information because I the sidelines, you might stray out of chances for success can be amplified. know I won't allow myself to be any- bounds or someone might think that When you trust your natural instincts where near that ethical sideline. I be- you did,” he wrote. “We strive to play in and avoid letting your emotions get in lieve that an investor should always the center of the field.” He calls it the the way of analyzing your investment take the extra step in staying within the "Football Field Test." choices, you'll know the great invest- field of the law. Whatever your decision, you would ments from the mediocre ones. At the be well served to always stray from end of this book you will have top On Developing a Watch-list: running out of bounds. Play in the mid- knowledge to build on and compound, Your watch-list is a dle of the field; if you run a properly which will serve you well over the executed play it is the quickest and years. critical component of shortest distance to the end-zone. a leisure investor. By Playing Within the Lines Always Have A Watch-list accumulating high Staying away from inside information Your watch-list is a critical component is another reason for investing as a quality businesses in of a leisure investor. By accumulating leisure activity. When you are en- your watch-list, and high quality businesses in your watch- trenched in the financial world, there list, and constantly maintaining them will be times when the lines of legality constantly maintain- over time, you will be prepared when or conflicts-of-interest become blurred. ing them over time, the market presents an opportunity to By being independent and being out of invest in a business on your watch-list. the influence of Wall Street, you can you will be prepared Personally, I have developed two pro- set yourself apart from the crowd. This when the market pre- prietary watch-lists over the last 10 is another reason I have chosen to years of researching businesses: a invest outside of Wall Street. sents an opportunity high quality business watch-list and a Not only does it limit distractions but I to invest in a business special situation watch-list. I consider never have to worry about the line of these two lists one of my biggest com- legality by mingling and having person- on your watch-list. petitive advantages. al conversations with top executives. Of course without inside information, Invest Leisurely!

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 24 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Amaya: Is It Time To Go All-In…? After purchasing PokerStars, Amaya is seeking re-entry to U.S. market. Does the market have this one right or is this an opportunity?

Amaya Gaming Group (AYA) went from an obscure, un- gaming in the U.S. Many of the U.S. poker sites packed up known company to an owner of the largest and best online and went overseas. However, PokerStars skirted around gambling sites in the world. Amaya's future was set in mo- this law by arguing that poker was not gambling, but a tion on August 1, 2014, after they acquired PokerStars for game of skill. $4.9B in cash (all figures are USD). Under these characteristics, PokerStars would not be Amaya is technology-based gaming solutions company subject to the UIGEA. This allowed PokerStars to gain sub- engaged in the design, development, distribution, sales and stantial market share in the U.S. as the government did not service of their products. Now their brands include Pok- enforce the law initially or fight PokerStars assertion of the erStars, Full Tilt, the European Poker Tour, PokerStars law. Eventually they were ejected from the U.S. in 2011 in Caribbean Adventure, Latin American Poker Tour, and the what the poker community commonly refers to as "Black Asia Pacific Poker Tour. These brands form the largest Friday." On April 15, 2011, the Department of Justice poker business in the world with over 60% market share seized the domain names for PokerStars and FullTilt. Both globally. companies, and their principles, were indicted for money Prior to being acquired by Amaya, PokerStars had a laundering and bank fraud. stranglehold on the U.S. online poker market with a ~70% PokerStars refunded all U.S. accounts instantly. Howev- market share. Globally they have ~60 market share. Cur- er, FullTilt player accounts disappeared on Black Friday. It rently, they are domiciled on the Isle of Man (British De- was rumored that management stole all the money. pendency) to benefit from the 0% corporate tax rate and PokerStars eventually acquired FullTilt through a settle- little-to-no rules regarding accepting casino and poker bets ment with the DOJ. As a show of good faith and good will, from the U.S. They hold many legitimate gambling commis- PokerStars paid FullTilt's portion of their fine and they vol- sion licenses in France, Denmark, Belgium, Italy, Spain, untarily refunded all accounts of former FullTilt players. Estonia, and the European Union. This gesture produced a ton of good will within the global Online poker took off in the early-to-mid 2000s. Online poker community. poker companies growing dramatically and then President Currently, all of PokerStars revenue is generated interna- Bush signed the UIGEA in 2006, essentially banning online tionally (majority in Europe). Their history with the U.S.

INVESTMENT SPOTLIGHT: Amaya (AYA)

Amaya (NAS:AYA) Description: Engaged in design, development, distribution, sale and service of tech based online gaming.

Price $20.70 52-Week Range $18.81—34.50 Dividend Yield N/A Enterprise Value $5.27B

Basic Valuation: P/FCF: 11.16 INVESTMENT SUMMARY Forward P/E: 10.62 As Amaya continues to deleverage, we believe the company should EV/EBIT: 21.00 garner a higher multiple and trade at least 20x free cash flow given their strong growth, high margins, low Capex requirements, operat- Notable Owners: ing leverage, and dominate competitive advantages. Shares appear BlackRock Tpg-axon to be worth at least $34 per share. PointState Odey Asset Sources: Company reports (10Ks, 10Qs, etc..), other public information

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 25 of 35 Investment Ideas For Intelligent Investors February 3, 2015 government helps explain why they haven't been granted a WHY THE MARKET IS MISSING THE OPPORTUNITY…? licence to operate in the three states that have legalized online gambling (New Jersey, Nevada, and Delaware). Markets Hate Uncertainty: However, the recent sale to Amaya should help clear up The true profitability and growth of the business in not the "bad actor" status that has kept them from regulatory currently understood. There is a great deal of uncertainty approval in the U.S. surrounding this business, but as our good friend Mohnish Many consider PokerStars a risky investment because Pabrai says, "Take advantage of Wall Street's handicap by they essentially went to war with the U.S. over the legality seeking out low-risk, high uncertainty bets...It's all about of online betting laws. However, it's our belief that the mar- only participating in coin tosses where 'Heads, I win; tails, I ket is missing critical investment events: (1) PokerStars' re- don't lose much." In general, the market has a difficult time entry to U.S. market is highly probable and imminent and distinguishing between risk and uncertainty. They get con- (2) rollout of sports betting and casino games to existing fused between the two very easily. Intelligent and savvy user base of ~85M registered players. And the market is investors who are able to take advantage if the market's focused on inconsequential issues: (1) broad-based selling shortsightedness should reap the rewards over time. in the Canadian market because the drop in oil, (2) concern As a result, we seek out the 'Heads, I win; Tails, I don't of federal and state regulation, and (3) the trading investi- lose too much" conditions because the market tends to gation of the PokerStars buyout. heavily discount these situations. Once the market comes to grips with the certainty there is normally a quick re- THE BUSINESS pricing /revaluation of shares - usually at much higher prices. We believe this will be the case with Amaya, if/when Online poker sites are high margin, incredibly profitable PokerStars gains re-entry to the U.S. markets. businesses. The business model is very stable and there is significant scalability options. Online poker businesses typi- Recency Bias cal exhibit very high margin and high double digits returns As much as the market hates uncertainty, it has a difficult on capital. It certainly fits our model for a high quality busi- time acting on something that's caused pain in the past. ness model. Investors have previously been burned by other publicly PokerStars earn revenue by collecting "rakes" on each traded poker companies in the past. Many of the publicly pot played. Rake is a small fee taken from each pot that is traded companies in the U.S. were decimated and lost in- played online. These fees can vary based on the size of the vestors a lot of money after the U.S. shut down online bet- games to the types of games. Individual games typically ting operations in 2011. Their negative perception of the range from 4.5% to <1%. Tournaments usually collect a 5- past has clouded an above average likelihood that certain 10% fee. A significant portion of this goes back to the play- events are likely to unfold in the next 3-9 months. ers in the form of loyalty rewards, bonuses, and rakebacks. Capex is minimal and big Capex is not necessary to grow Anchoring Bias: or maintain the business. Working capital is also not need Prices have increased from $5 in 2013 to over $20 per to grow and its not uncommon to operate with negative share in 2014. This gives the impression to investors that working capital because of customer accounts. In addition, they've "missed the boat." taxes are minimal due to the company being domiciled on Prices have certainly increased a significant amount the Isle of Man. since news of Amaya acquiring PokerStars. However, a We believe we have the opportunity to invest in a busi- stock increasing 300% doesn't mean we change our ascer- ness in the very early stages of a growth phase, with an tion that the stock still has a long run way of growth. Even extremely attractive business model, a dominant leader with the recent run-up in share prices, we believe shares with >60% market share, numerous competitive ad- should be trading at much higher multiples. vantages, and extremely undervalued business given it's The numbers and the valuations are not easily computed high quality and future growth characteristics. and, as a result, easily disregarded: Each country (and state) has their own regulatory board The smaller company acquiring the bigger company has that must approve gambling institutions operating in their made the company financials messy. This leaves the back- jurisdiction. The majority of Amaya's revenue is generated ward looking filings almost irrelevant in trying to understand in regulated areas in the EU. As new areas and jurisdic- and value the business. tions begin to regulate, this can add to the growth potential Most analysts and research firms can't (or won't) value of the overall market. businesses with limited operational history. And without the ability to value the company, it means there will be little-to- no sell side analyst and brokerage coverage.

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 26 of 35 Investment Ideas For Intelligent Investors February 3, 2015 The numbers and the valuations are not easily comput- from various interest groups. ed and, as a result, easily disregarded: In addition, the market seems to be concerned with the The smaller company acquiring the bigger company has Federal Government banning online gambling in the U.S. made the company financials messy. This leaves the back- altogether. We believe this is unlikely for a number of rea- ward looking filings almost irrelevant in trying to understand sons - the most important being that it's un-American. And and value the business. Most analysts and research firms we would liken it to the prohibition (I know that's aggres- can't (or won't) value businesses with limited operational sive). history. And without the ability to value the company, it There are split views on the hill as to the acceptance of means there will be little-to-no sell side analyst and broker- online gambling in the U.S. Various industry leaders and age coverage. contacts in D.C., tell us that any bill (even if it made it out of PokerStars was a private company with no debt prior to a committee) would have a very low probability of passing. being acquired by Amaya. The online poker industry is new Especially because U.S. states have already started to to many analysts and many investors are not familiar with adopt legal online gambling provisions. In addition, online the business. In addition, there are no comparable in the lottery tax revenues would be at risk. north American market. Personally, I play poker recreationally (online or with Because PokerStars was private, there is very limited friends). It's fun, exciting, and has all the components of information available regarding fundamentals, size, and value investing that I love - math, probability, behavioral growth prospects. The Q3 report revealed their impressive psychology, and game theory. Instead of spending $50 to earnings capability for the first time. So it's still relatively go to the movies or a ball game, I can buy-in for $50 and unknown to most of the investment world. have the potential to make money while having a great time Although we believe the acquisition of PokerStars was a in the process. Poker isn't bad for society. Like any card brilliant move by David Baazov, we also acknowledge his game (and most things in life), if you act responsibly and future ambitions. A large M&A acquisition spree may not be have fun, it can be a great experience for everyone in- looked upon by the market favorably. We wouldn't neces- volved. sarily be opposed to Amaya gobbling up competitors to We believe politicians will change their tune soon protect their market share, as long as they were making enough. In fact, it's already happening. acquisitions in a savvy manner and at reasonable multi- Slowly, but surely, online gambling is coming back to the ples. The true underlying fundamentals of the business are U.S. Three states have already allowed online gambling likely to show through in the next few quarters. within their borders - New Jersey, Nevada, and Delaware. See the section below, "U.S. entry is a major catalyst," for And 20 states are expected to allow online gambling by conservative estimates of future revenue and earnings. 2020. It's our belief that New Jersey will start a cascading effect Investigation into the pre-deal Price Action: since seeing the Italian market grow 62% year-over-year 30 days prior to the announcement that Amaya would when PokerStars entered their market. We believe New acquire PokerStars, shares climbed more than 50%. There Jersey sees the potential positive effects of the PokerStars were numerous rumors of a merger weeks before the an- brand, and what they bring with to the table with their one- nouncement. This prompted an investigation by Canadian of-a-kind user network effects and liquidity. authorities into potential wrong doing. If New Jersey starts generating significant revenue from Shareholder recently voted overwhelmingly in support of PokerStars re-entry, we believe you'll see other states start the board of directors with 96% approval. Amaya was re- to make provisions for online gambling and allow Pok- cently vetted by prior to joining the Nasdaq by securities erStars entry. It would be a domino effect of some sort. regulators in the U.S. Based on our research, we believe significant growth lies We view this as a non-issue. ahead as the U.S. allows PokerStars to re-enter the U.S. market. The entry to the New Jersey market will be the cat- The market is not sold on U.S. re-entry for PokerStars: alyst that allows PokerStars to enter the rest of the U.S. Amaya and PokerStars have made all the right moves to market. put themselves in a position to gain entry to U.S. markets. Municipalities (and the federal government) need reve- They already have significant goodwill across the globe nue to finance projects and provide for their citizens. The and in the poker community. approval of online betting is just another way for the state It's only a matter of time before the U.S. sees it too. As and the U.S. government to generate revenue. And at the we know, politicians can be slow to act at times (especially very least, it's better than approving another gaudy casino. during election periods). And many believe the online gam- Bottom line: municipalities and the federal government bling tax revenues just aren't worth the time and annoyance need new sources of revenue. It may not seem like a

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 27 of 35 Investment Ideas For Intelligent Investors February 3, 2015 great deal of revenue at the federal and state level, but re-entry into the U.S. market should help strengthen and they really need to find multiple sources of new revenue. widen their moat in the online poker and betting market. This is a step to make that happen as the federal govern- Prior estimates of PokerStars' market share in the U.S. ment and municipalities continue to run deficits budgets. pegged them at ~70% total market share (revenue). Here This makes for a great political talking point as they pander are the most recent global market share estimates for Pok- to their constituents. However, we believe it's just noise erStars: before the ultimate re-entry in the U.S. market.

INVESTMENT OVERVIEW

Strong Competitive Advantages Internationally via Net- work Effects and Brand Recognition: Because it's such a new industry, market participants have a difficult time ascertaining potential competitive advantages in the online poker industry. It cannot be stated enough, that this is a high quality business with numerous competitive advantages. The user base, and the network effects associated with it, is the most important component of a high quality online poker site. As a recreational poker player, I know firsthand what I look for when picking sites for games: a large user base. PokerStars has, by far, the biggest online poker user base with ~85M players (w/o US). It is a determining factor in how professional and recreational players choose which U.S. Entry is a major catalyst: sites to play and trust. Having such a large user base of Amaya CEO David Baazov stated on June 9, 2015, that players allows players to search for the best game condi- he expected PokerStars to be licensed in the U.S. within tions 24 hours a day. the next 30-90 days. This timeline may or may not occur. Larger user bases also provide for numerous options for However, we believe it's just a matter of time before Pok- the tournament player enthusiasts. These tournaments erStars gains re-entry to U.S. markets. come in many forms, such as sit-and-go tournaments, land Online poker growth within the U.S. essentially had its based events, and the big multi-table tournaments with the knees cut out from underneath itself in the early stages of a massive payouts. Because of its size and player base, Pok- major growth phase. erStars offers weekly tournaments with payouts over $1 Let's take a look at some conservative financial assump- million dollars. They consistently send over 1,000 players tions that can act as a potential catalyst for re-pricing of to the World Series of Poker every year. shares. See the potential valuation change when Pok- These kinds of network effects cannot be understated in erStars gains re-entry into the U.S. markets: the online poker market. It provides a significant moat. Pok- erStars has done an excellent job growing that moat through player's growth and marketing campaigns using professional poker players and athletes (similar model to Nike). As we know, the gambling industry does not have the best reputation. PokerStars would be the exception to this common stereo-type. An example of this would be Pok- erStars repaying all FullTilt player accounts which were allegedly stolen by FullTilt management -- something they didn't have to do. This has helped them build goodwill while strengthening their trustworthy reputation. In addition, they have the best software technology in the business and can handle extreme traffic loads (>600k players at one time). This scale advantage allows them to offer lower rakes than their competitors. This is the equivalent to a low cost operator, which helps strengthen their moat. The Source: Author, with author's own estimates

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 28 of 35 Investment Ideas For Intelligent Investors February 3, 2015 We assume an average of Morgan Stanley's low-line U.S. Market is not pricing in vertical and horizontal product market potential ($2.7B by 2020) and Academicon's esti- offerings: mate ($2.2B) will come to fruition over time. We also as- This may be the most important part of our investment sume that PokerStars is able to gain a 40% market share, thesis. PokerStars is essentially a poker company. Histori- which is well below the 65%+ it garners internationally. And cally, they have not offered other casino table games, it's also well below the ~70% market share it garnered in online slots, or sports betting. Although online poker is the U.S. prior to Black Friday. Free cash should track growing, it only accounts for $4B in annual revenue. Online closely to EBITDA since there have extremely low Capex sports betting generates $17B and all other online gaming requirements and little to no taxes. We expect interest pay- accounts for $8B. In addition, the margins are higher in ments to subside over time as well. So this should be a sports betting and casino games. fairly conservative number of free cash flow. Their 85M player base provides for enormous potential Current revenue is 1.07B with EBITDA of $408B and free when they roll out the sports betting and casino platforms. cash flow of $338B. This gives us an EBITDA margin of There's already tested the strategy on the smaller FullTilt 38.40% with free cash at 82.80% of EBITDA. Based on 2 and PokerStars.es platforms, and they've reported double reports of the U.S. online Poker market we average the two digit cross sell rates already. estimates of $2.2B and $2.7B. This gives the U.S. online This is extremely important for two reasons: (1) increase poker market a potential $2.45B market potential. in revenues at higher margins and (2) they don't need to Remember, PokerStars had a ~70% market share ru- pay to acquire customers. With a player base of 85M, the mors. But let's assume they only capture 40% of the market cross-sell potential across the entire platform should be (very conservative). This gives us a potential revenue seamless. boom of ~$1B at a 40% market share. With an EBITDA PokerStars has seen competitors roll-out cross sells suc- margin of 30% and free cash flow at 80% of free cash flow, cessfully. And the data they've compiled over the years we see a free cash flow estimate of $240M. We believe shows that a large proportion of their active player base bet these margins are well below the actual margins. on sporting events and/or play casino games. This should This is a conservative 72% increase in free cash flow that allow them to increase earnings significantly over the short- the market is ignoring from only one of our two major cata- to-intermediate term with very little friction. lysts. They haven't spent a dollar on marketing these products With these new financials in place with the re-entry to the and they haven't launched it on mobile yet. 45% of their U.S. markets, it changes the business fundamentals dra- users are on mobile. They're already producing $36M in matically. If shares were still trading at current levels, you'd quarterly revenue (11% of total revenue) from these plat- have a business trading at ~5x free cash flow, EV/EBIT forms and it's not even close to being rolled out and fully ~10, P/E ~5, FCF/EV of 10. Very cheap ratios and metrics optimized. Just think about that for a second. that the market is not considering. Sell-side analysts will be quick to adjust their valuation models and price targets. We wouldn't be surprised to see a quick re-pricing of shares at ~$50 per share. Ultimately, we believe shares could be worth ~$100 per share with continued growth rates in the next 3-5 years. Previous U.S. online markets potential and growth estimates were severely overstated. However, recent growth estimates have come down to realistic levels and this provides the opportunity for Amaya and the U.S. online poker market to surprise on the upside. Morgan Stanley has ratcheted down US online gambling estimates from projec- tions as high as $9.3B to $2.7B by 2020. We'd rather step over a 1-foot pole, than try to jump over a 10-foot pole. The U.S. is the world's largest economy. Access to this country would be a major boost to future revenue and earnings from Amaya. No other country do you see this amount of people with discretionary income and internet access. Full U.S. market value of all 50 states is expected to be around $10B. There is a long wave of growth potential in the future. The market has not come to grips with this yet.

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 29 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Removal of Old Ownership and Leadership should nul- base, and liquidity. They would be able to turn this around lify bad actor status and could pave the way to re-entry almost overnight. We would not be surprised to see online in the U.S.: poker revenue jump back to 3.5M per month figure and One of the main reason PokerStars was sold to Amaya beyond. We envision that online casino revenue would was because previous owners realized they would have a have a significant jump as well and help NU get back on difficult time gaining approval for U.S. markets because of the path to growth. This would be great for both New Jer- their "bad actor" status. sey and PokerStars. It's a win-win for both parties. The underlying structure of the acquisition was conducted in a way that would exclude PokerStars as a "bad actor" Organic Growth Internationally with a new and entirely different management team and Regulation in the gambling market is always a risk. Pok- ownership. We do believe the Amaya is cheap at current erStars is extremely well diversified across numerous coun- levels without access to the U.S., however, we do believe tries around the world. The majority of their revenue is gen- they'll be approved under new ownership. erated from stable governments. This approval will be a major catalyst for market partici- The online gaming market is growing rapidly. Amaya is in pants to accept and understand their potential growth in the the early phase of, what is likely, to be a long wave of U.S. growth in the U.S. and abroad. Annual growth rates are PokerStars re-entry will be a major catalyst for the stock almost 15% in the EU. The U.S. is likely to experience simi- and should help to create a domino effect of state approval lar rates once more states adopt online gaming. and acceptance. This could be a game changer for the entire business over the next few years. CEO Baazov, reiter- ated that PokerStars NJ remains "on track" for approval. It's interesting to note that he made no mention of the New Jersey market in the most recent quarterly presentation in August. We believe this could be for two reasons: the New Jersey approval has hit a standstill or he is trying to temper expectations and verbiage to the New Jersey regulatory authority. We believe it's the later. The issue of late for U.S. re-entry approval was the discussion around the "bad actor" clause. The argument against PokerStars approval in the U.S. is their past indis- cretion with failing to follow the UIGEA. This stamped them as a 'bad actor.' Anyone classified as a 'bad actor' has almost a zero percent chance of operating in any state with that status. Regardless of U.S. re-entry, organic growth and the contin- Yes, PokerStars operated in the U.S. after UIGEA. And ued growth internationally at 10%+ should provide a wave the purchase of the company with new ownership doesn't of profitability over the long-term. In addition, Amaya has exclude them from 'bad actor' status (IMHO). It's their ac- targeted other online gaming verticals within the interna- tions and their stellar reputation that exempts that from 'bad tional markets (notably casinos and sportsbooks, and fan- actor' status. Their actions since Black Friday have been tasy sports), which complement its core online poker busi- nothing short of stellar and they've done everything needed ness. to put them back in the good graces of regulatory authorities in the U.S. and Globally. PokerStars is already gaining momentum and acceptance from various state groups. We believe that New Jersey is a prime location for approval for PokerStars for a few reasons, but the main reason being: they need the money (every municipality needs money for that matter). NJ online casino revenue has been trending upwards, however it appears casino revenue has stalled at current levels. And online poker revenue has declined from a high in 2013 at $3.5M per month. It appears to be stabilizing around $2M per month right now. Because of PokerStars brand presence, 85M player user

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 30 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Amaya has continued to grow in Eu- (larger discount between current prices cycles at times. Given the early stages rope and Canada despite both of the and the Intrinsic Value of the Busi- and expectation of continued growth, economies slowing down over the past ness). A higher quality business or in- we will use TTM free cash flow of few years. We believe the company vestment doesn't necessary require a $338M. will continue to grow regardless of the large discount to intrinsic value if you We'll be conservative, and use a little local economies. If local do begin to expect (with a high degree of probabil- less than TTM free cash flow, $330M -- grow, we believe this will be icing on ity) that returns will be realized shortly just to give us an even bigger margin the cake. or returns of the business will com- of safety. Numerous markets around the world, pound over time. We will use a conservative discount including Russia, are looking at regu- Regarding valuation, the margin of rate of 10%, given the high quality na- lating their respective markets, so safety can be accomplished in one of ture of the business. that's another factor that helps create a two ways (or both for that matter): And even after all the DCF projec- long runway for growth. 1) Purchasing the conservative esti- tions, the business is still worth some- mate of future free cash flows of the thing at the end of the day (all else be- Management is shareholder friendly business at a discount ing equal). So we assume that the and incentivized properly: 2) Purchasing a business below its business is sold at the end of the year President and CEO, David Baazov, liquidation value with favorable earn- 10 at a conservative 10x FCF plus any founded Amaya. He's led the company ings power in 3-5 years. excess capital in the business. Amaya since 2006. Although he is only 35 In the case of Amaya, we will be val- had $350 in cash of TTM, so we'll use years old, he has done an amazing job uing the business based on its dis- this as a conservative number of ex- in acquiring PokerStars and has a counted future free cash flows to deter- cess capital. great vision for the company. Here is a mine if there is a margin of safety. They have embarked on a share re- recent profile on Forbes. In valuing any business, it's im- purchase program. However, we want He has a large stake in Amaya portant to focus on free cash flow (as to be conservative in our assumption. (12.5%). We think he is plenty incentiv- well as the durability of its competitive So we'll use current 200M shares out- ized to make decisions that are in the position). standing in our calculation (although best interest of shareholders. In valuing Amaya, let's start with the we believe this will be much less over Recently, the company announced a FCF number. time). share repurchase program to purchase Amaya had Cash Flow from Opera- Based on these numbers, and to be up to 5,399,631 common shares by the tions of $364M in last twelve months. very conservative, we will come up end of 2015. This represents 5% of the Capital expenditures for the last year with 3 growth scenarios for Amaya public float. They intend to fund the were $26M. The "back of the enve- over the next 10 years. We'll also give purchases through proceeds of non- lope" net free cash flow was about a probability weight based on the likeli- core divestitures and cash on hand. $338M. We think this is a very con- hood of each scenario. Let's look at the Their philosophy of repurchasing servative number, as recent free cash three scenarios below using these vari- shares at discounts to the underlying numbers are already coming in higher. ous assumptions, and see how we value of Amaya should be a welcome PokerStars revenues and earnings were able to arrive at a fairly conserva- sign to all shareholders. are just showing up on Amaya's quar- tive estimate of intrinsic value using a terly statements, so it's tough to get a range of values and probability of the VALUATION long-term view. However, looking at scenarios playing out:. See valuations the TTM we see incredible return on at the end. On the valuation front, Amaya sports a equity and invested capital, 33% and The discounted cash flow values of P/FCF of 11.68 (FCF yield of 8.56, EV/ over 250% respectively. Amaya range from $23.89 to $42.60. EBIT of 21.54, forward P/E of 11.00, It appears Capex is appears relative- The stock is trading ~$21 per share and P/S of 4.08. ly stable in the $25-35M range. We which gives a large margin of safety to The future is inherently unknown and would not be surprised to see this our weighted and high range assump- unpredictable (to any high degree of higher over time as they continue to tions. We believe the most likely sce- probability). Because we weren't grow. nario is 10-15% growth in FCF in the blessed with a crystal ball, we believe Amaya operates in a cyclical indus- foreseeable future, which is why we a margin of safety is ESSENTIAL in try. However, the industry is in very weighted scenario #2 and #3 at 40% every investment. early stages and continues to grow at probability each. A larger margin of safety is recom- a rapid rate. Down the line, it may be This gives us a weighted intrinsic mended for lower quality investments subject to the wide vagaries of market value of $34.52 per share. With shares

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 31 of 35 Investment Ideas For Intelligent Investors February 3, 2015 trading at ~$21 per share, it seems like an interesting op- the first year alone (we believe this to be conservative). portunity at current levels. With PokerStars' previous ~70% market share, you're look- REMEMBER: These calculations do not take into consid- ing at more than a doubling of revenue and earnings just eration PokerStars re-entry to the U.S. markets or the free from the re-entry to U.S. markets alone. cash flow jump in cross selling new complementary product Ultimately, it could be a month or it could be 5-10 years lines. As we discussed above, we could see free cash flow before PokerStars re-entry to the market. Regardless, ~578M shortly after re-entry. We'll be conservative and use Amaya looks to be an attractive investment at current lev- the same estimates above, but we'll use only $500M as els with its potential to grow organically from new vertical Amaya's real free cash flow. This is a very conservative and horizontal product lines being rolled out. PokerStars number we believe will be reached in the next 6-18 months. entry to the U.S. is just icing on the cake. As you can see, our conservative estimates dramatically There are numerous ways to win with this investment at changes the future valuation of the business (~50% in- current levels, with these three being likely scenarios: Ama- crease). We get significant economic power at current lev- ya continues to grow its Pokerstars platform internationally, els without U.S. re-entry. But we have a kicker -- U.S. re- new product roll outs to existing user base provides an im- entry is a significant catalyst that we believe has a high mediate significant earnings increase, or PokerStars gains probability of approval. It's a classic case of 'heads, I win; re-entry into the U.S. markets. Our research leads us to tails, I don't lose much." believe that there is a high likelihood of all three. As Amaya continues to deleverage, we believe the com- Investors should do well long-term through their invest- pany should garner a higher multiple and trade at least 20x ment in Amaya at current levels (and lower). free cash flow given their strong growth, high margins, low Capex requirements, operating leverage, and dominate Notable Shareholders: competitive advantages. BlackRock | PointState Capital | Capital Research | VA Col- BOTTOM LINE legeAmerica | Odey Asset Management | GSO Capital Partners | 1832 Asset Management We believe the market is missing a big opportunity here when PokerStars is allowed to re-enter the U.S. market and *Figures Source: Company Presentation the cross selling of the Sports Betting and Casino Platforms are rolled out in the next few months. We've seen U.S. **See two market share reports here: Morgan Stanley, online poker revenue market estimates between $2-3B for Academicon

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 32 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Low-Range Scenario #1: 5% growth in FCF for years 1-10

Mid-Range Scenario #2: 10% growth in FCF for years 1-10

High-Range Scenario #3: 15% growth in FCF for years 1-10

© 2014-2015 by InvestorVantage. All right reserved. JOIN TODAY! InvestorVantagecom September 2015 — Page 33 of 35 Investment Ideas For Intelligent Investors February 3, 2015 Value Investor Screens (1 of 5) U.S. Net-Net Stocks Companies trading below Net Current Asset Value, filtered by EV/EBIT

Company Name Ticker Market Value Enterprise Value Current Price NCAV 66% NCAV P / NCAV P/TBV EV/EBIT

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