Graham and Doddsville An investment newsletter from the students of Columbia Business School

Volume II, Issue 2 Summer / Fall 2008 Inside this issue:

Joel Greenblatt p. 9 Making Heads and Tails of Mohnish Pabrai

Visiting the Oracle p. 10 Mohnish Pabrai launched Pabrai by the Indian approach called Funds in 1999. Less than a dec- Dhandho. When asked about Pershing Square p. 14 ade later, Mr. Pabrai’s name is his investment philosophy, he Challenge often mentioned in the same often repeats the mantra breath as legendary value inves- “Heads I win, tails I don’t lose tors who have been in the busi- that much.” Graham and The Winning Pitch: p. 16 Doddsville was lucky enough to NutriSystem ness for decades. The Pabrai Funds annual shareholder meet- sit down and delve deeper into ing has become a stop on a Mohnish Pabrai’s investment 11th Annual CIMA p. 18 value investing tour that in- philosophy. Conference cludes the annual meetings of Berkshire Hathaway, Wesco, Question: How did you get Advice from The p. 21 and The Sequoia Fund. He is started with value investing? Oracle also a frequent guest of Bloomberg, CNBC, and The Mohnish Pabrai—Pabrai Funds Until I was 30 years old, frankly, Value Investing Congress. I had never heard of Mr. Buffett. Editors: spent the afternoon of July 25 I had never heard of value in- vesting. This was 1994 and I In 2007, Mr. Pabrai published his with their mentor. second book, The Dhandho In- was vacationing in London with David Kessler vestor , which is quickly becoming In April, Mohnish made his first my wife. I was looking for MBA 2008 a ‘must read’ for all value inves- appearance at Columbia Busi- something to read on the flight tors. Last year, along with Guy ness School where he appeared back to Chicago, and I picked up Charles Murphy Spier, manager of Aquamarine as the guest lecturer in Profes- one of Peter Lynch’s books. I MBA 2009 Fund, Mr. Pabrai was the highest sor Bruce Greenwald’s Value am an engineer by training, so bidder in an eBay auction for Investing Seminar. Mr. Pabrai’s this was a different field for me. lunch with Warren Buffett. investment style has not only I read that book on the flight David Silverman With his daughters sitting on been influenced by Benjamin and I loved it. It made all the MBA 2009 either side of Buffett, Mr. Pabrai, Graham, Warren Buffett, and sense in the world to me, in Mr. Spier and their families other value investors, but also (Continued on page 2)

Contact us at: Graham and Doddsville Celebrates the 75th [email protected] Anniversary of Graham and Dodd’s Classic Visit us at: www.grahamanddodd.com Welcome back to Graham and cation of the sixth edition of eration of investors who follow www.gsb.columbia.edu/students/ Doddsville! The summer has Security Analysis . This edition the framework set forth by organizations/ cima/ come to an end, and a new comes as we celebrate the 75th Graham and Dodd. This issue school year has begun amidst anniversary of the first edition, is no exception, and we are the largest shake-up on Wall published in 1934. Professor especially pleased to present an Street since the Great Depres- Bruce Greenwald continues interview with Mohnish Pabrai sion. While the times have Columbia’s rich tradition of of Pabrai Funds. changed, the original tenets of value investing as co-editor of Columbia Business School Pro- the new edition along with Jim Inside you will learn from inves- fessors Benjamin Graham and Grant and Seth Klarman. tors such as Warren Buffett, David Dodd remain the same. Joel Greenblatt, Bill Ackman, Graham and Doddsville strives Rich Pzena, Daniel Loeb, and Along with the new school year, to bring you insight and infor- many others. We are also September also marks the publi- mation from the current gen- (Continued on page 2) Page 2

Graham And Doddsville Celebrates… (continued from page 1)

(Continued from page 1) proud to feature Shilpa Marda’s winning pitch from The First Annual Pershing Square Chal- lenge.

This year promises to be an exciting one for all investors. We will continue to bring you insights from some of the most prominent citizens of Graham and Doddsville. If you have any comments or suggestions, e-mail us at: [email protected].

Go online to find this and past issues of Graham and Doddsville, as well as other resources from CIMA: Erin Bellissimo, co-director of the Heilbrunn Center, and professor Dan Kruger, Professor of Distressed Value In- http://www0.gsb.columbia.edu/ vesting catch up at the 11th Annual CIMA Conference students/organizations/cima

Mohnish Pabrai (continued from page 1)

terms of how to and how not The thing that I found very ‘winging it’. That is how I saw “The thing that I to invest. I thought this was an strange was that if there is such mutual funds work – they were interesting area and I wanted a thing as the laws of investing, just winging it, or they come up found very strange to know more about it, so I Warren Buffett has pretty with any nuance or ‘flavor of found that Peter Lynch had much laid them out. What I the day’ they want to pursue. I was that if there is another book and I read that couldn’t understand was that had a thought that if novices one too. I wanted to learn when I looked at the entire like me simply adopted Buffett’s such a thing as the even more, but I ran out of mutual fund industry at the approach and invested in the Peter Lynch books to read. I time, which were the profes- equity markets with a concen- laws of investing, remembered that in one of the sional managers that I had ex- trated portfolio, etc. that I was books, Peter Lynch mentioned posure to, I saw that these guys likely to do better than most of Warren Buffett has Warren Buffett and told a not only did not follow the the industry professionals. So I story of how Buffett had called fundamental laws of investing, said it was worth testing this pretty much laid him to get his permission to but most of them didn’t even hypothesis out. I was lucky at use a quote. This was the first know what they were. At the the time in 1994; I had about them out.” time I had ever heard of War- same time, their results re- $1 million in cash. I had just ren Buffett. I figured since flected sub-par performance. sold some assets of my busi- Lynch was talking to Buffett, I So I thought there must be a ness and I decided to go ahead should learn more about who correlation between these guys and manage that in a Buffett- Buffett is. I looked around, and not following the rules and style concentrated portfolio, found the first two biographies having poor performance. buying things I understood, etc. that had just been published: That is how I got into value Lowenstein’s The Making of an The second thing I found very investing. American Capitalist and Hag- strange was how you can have strom’s The Warren Buffett an entire industry which does Question: You have man- Way . I read those books and I not function with a solid frame- aged Pabrai Funds since just had an epiphany. They work. To me, it is like people 1999. That must have resonated strongly with me. doing brain surgery by just (Continued on page 3) Volume II, Issue 2 Page 3

Mohnish Pabrai (continued from page 2)

(Continued from page 2) Question: Where do you is in fact a good invest- been quite a time to open a hunt for your ideas? ment? “What I couldn’t value fund. When I look for ideas, I look in After I identify an interesting Actually, 1999 was very inter- places like the 52-week-low company, I begin to drill down understand was esting. I think it was a great list, Value Line , as well as stocks reading the 10K’s and 10Q’s. time to start as a value investor with low P/E ratios, low P/B When I first come across a that when I looked because the market in 1999 ratios, or large discount-to- business, I generally ask myself and 2000 had segregated. As a book value. Now I have Joel within the first few minutes: Is at the entire mutual matter of fact, on the day that Greenblatt’s Magic Formula; I this something I understand the NASDAQ hit its peak, look at that on a daily basis as well? Is this a relatively fund industry at the Berkshire hit its 52-week low. well. I also subscribe to Portfo- straight-forward business to What happened is that a lot of lio Reports , published by Out- understand? If I am not getting time… I saw that money had gone into these standing Investor Digest , which a clear idea in my head of how frothy dot-com type stocks, gives a listing of all the buying the business works and how it these guys not only but effectively it had come out of major value investors every makes money, then I will gen- of brick-and-mortar, normal few weeks. I also look at 13F erally stop and move on to the did not follow the businesses. A lot of brick-and- filings of the usual suspects next business. In fact, I often mortar, real-world businesses such as the Fairholme Fund, move on if I can’t answer that fundamental laws were trading really cheap. So it Marty Whitman, Einhorn, and question right way. So the first was actually a great time to go all of those folks. That is basi- question you have to ask your- of investing, but into the equity markets as long self is: In general, is this a busi- cally where I go fishing. most of them didn’t as you didn’t drink the same ness I can understand? I made Kool Aid that everyone else Question: What are char- an investment in 2001 in a was drinking. In fact, after acteristics of the compa- company called Stewart Enter- even know what Pabrai Funds’ first year, in June prises which is in the funeral nies that attract you? they were. At the 2000, we were up approxi- services business. I can under- mately 38% after fees. Then In general, I look for industries stand that business. You bury the second year we were up by with a slow rate of change, people, cremate them, you get same time, their mid- 30% after fees. We did companies with some type of paid, etc. Then you can start really well in the year when moat, and companies with hard to think about understanding results reflected everything crashed and burned, the finer points, such as the assets. I look to buy businesses s u b - p a r for that reason. where I can rest my hat on the brand, and what people think hard assets of the business. about the community of funeral Question: Over the past Other times, I look at busi- service providers. It is not a performance. So I 10 years, how have you nesses that have more of a business where a competitor seen the value investing franchise value, so the intrinsic can open up overnight with thought there must cheaper pricing and just take landscape change? value is made up more of intan- be a correlation gibles such as brand, etc. Basi- your business away. Then, There isn’t much of a change. cally, what I’m trying to do is there is the fact that it is rare The good news is that there is find businesses that I can buy for someone to aspire to go between these guys now more of a community with well below what they are into the funeral business. In things like Whitney’s newslet- worth. I usually try to make general, it is not an attractive not following the ter (Value Investor Insight), one bet per industry, and I business for a 25-year-old to conferences, and the Columbia typically put 10% of the fund’s think about entering, so it rules and having Value Investing Program. assets into each idea. An ideal keeps the number of new en- Clearly there is now more portfolio would be comprised trants down. Finally, all hu- poor performance.” interest. However, if you look of 10 positions from 10 differ- mans eventually die. They may at all of the people involved ent industries all priced at a live longer, but eventually we with investing in the equity discount to what they are die, so you also have a steady markets worldwide, the per- worth. In terms of what ex- stream of customers coming in. centage of them that focus on actly I focus on is determined true value investing is still a by what is on sale. So these are the kinds of things very, very miniscule percent- to think about when you start age. I think that, in general, the Question: Once you iden- thinking about a business. If opportunity to do value invest- tify a potential investment they all make sense, then you ing is almost as good as it was idea, what is your process can begin to look further into 10, 20 or even 30 years ago. for determining whether it (Continued on page 4) Page 4

Mohnish Pabrai (continued from page 3)

(Continued from page 3) the most important tenets that Question: As a value inves- the business at things like value, Ben Graham talked about. You tor, you have mentioned why it is trading where it’s always want to ask yourself you look out over the 3- to trading, what it is really worth “What is my downside?” You 5-year period. Wall Street and so forth and so on. also want to get some comfort obviously has a much that you have some protection. shorter horizon. How do Question: You have often In some cases, you can get that you maintain the tempera- said that you look for dollar comfort from liquidation value ment to hold a security the bills that are selling for or hard assets minus liabilities. time it takes to realize its much less than a dollar, In other cases, you may get value? then you need to have the comfort from somewhere else. strength to be patient and For example, if you look at a I’m very blessed with the inves- wait for the rest of the tors I have at Pabrai Funds. I In 2007, Mohnish world to realize it is worth have about 400 families across Pabrai published his a dollar. As MBA students, “I have always the five funds I manage at second book, The we are often asked for Pabrai Funds with over $550 Dhandho Investor stock ideas when we inter- million in assets and on a typi- view for summer intern- felt that value is cal day, I never hear from any ships or full-time positions. of them. I have an annual The first question that we its own catalyst shareholder meeting that many are often asked is “what is of my investors show up to. It the catalyst for your idea and that is a great group of investors. to reach its intrinsic Even recently, with the market value?” How do you think turmoil, I really haven’t had about catalysts when you eventually the many e-mails or calls. I love to are making an investment? partner up with these types of stock market folks. So I don’t really face I don’t focus on catalysts. I much pressure from the inves- have always felt that value is its becomes a tor base. own catalyst and that eventu- ally the stock market becomes Second, I generally don’t dis- a weighing machine and will weighing cuss the existing portfolio posi- weigh stocks correctly. I re- tions. That keeps a lot of the cently bought into a European machine and noise down. Third, I think the company that trades at about temperament or patience 1/3 of its hard asset liquidation will weigh stocks comes in part from the way we value. I can’t see any real cata- are wired or the way we can lyst in that business. I couldn’t learn, or not learn, from Ben tell you when or what event correctly.” Graham, Warren Buffett, etc. will make that value converge, You know, Warren Buffett has but if something is trading at company like Moody’s or said many times that people 1/3 of what it’s worth, I think American Express, you couldn’t either get value investing in five that if you are just patient for a invest in these based on liquida- minutes or they won’t get it in few years, it is highly likely that tion value. If their brands were five years. So, there is some- you will make money and it is permanently impaired, you thing in the human wiring of highly unlikely that you will lose would probably be losing our brain that, for some of us, money. money. However, as long as makes all the difference in the the brand continues to grow in world right away and the pa- Question: How do you value, you can end up making a tience that it requires is part of think about downside risk? lot of money. When you are that wiring process. For oth- looking at the margin of safety ers, they may buy into the con- At Pabrai Funds, I have made you can look at it in terms of cept completely, but they tem- several mistakes in the past and hard assets like Ben Graham peramentally just don’t have I’m sure I’ll make several more used to, or you can look at it in the patience. in the future. You always need terms of more intangible assets to protect the downside risk. I which can be very valuable. Question: When do you think margin of safety is one of (Continued on page 5) Volume II, Issue 2 Page 5

Mohnish Pabrai (continued from page 4)

(Continued from page 4) Question: Several value- go up in value. So the starting think about selling an in- oriented hedge fund man- point of a short bet is to have vestment? agers that have spoken to head-winds against you. That is our class this year talked the first problem. I typically try to buy things for about the advantage they fifty cents or less and I start to have to go both long and The second issue is that the think about selling them when short the market. I know maximum you can make if you they get to be worth ninety that you have different short a stock and it goes to cents or more. When things opinions about shorting zero is double your money. Professor Bruce Greenwald and are above ninety percent of stocks. The maximum you can lose is Dean Glenn Hubbard intrinsic value, they become infinite, because a stock can candidates to be sold. Of I think that Charlie Munger keep going up, but can only go Columbia Business School is course I factor into the deci- expressed it really well at this down to zero, so you don’t a leading resource for invest- sion things such as long-term have a symmetrical risk-reward ment management profession- vs. short-term gains or what relationship. The maximum als and the only Ivy League other opportunities there are you can make is two times “I think the business school in New York for the money. When things your investment; the maximum go to one hundred percent of you can lose is everything. It is City. The School, where value intrinsic value, I would be look- temperament or a poor bet to have those types investing originated, is consis- ing hard for replacements or of odds on any bet you are tently ranked among the top thinking about going to cash. patience comes making. programs for finance in the world . Question: In the past, in part from the Third, I think it is so much what were some of the easier temperamentally to go signs that made you realize way we are long on a business. If you short you had made a mistake? a business, you either have to put up stop-losses, or end up At all times, you have to be wired or the way on a leash glued to a monitor asking yourself the question all hours the market is open. I “What is the business worth?” we can learn, or don’t believe that is a very and “What is the intrinsic value productive way to live your life. of the business?” A couple of I’m usually drooling on my things can happen. First, you not learn, from pillow on the West Coast could have made a mistake on when the markets are opening. what you thought the business Ben Graham, So it certainly wouldn’t work was worth and you could later for me since I generally don’t have realized that it isn’t worth Warren Buffett, look at the market until several what you thought it was. In hours of the trading day have this case, you should look at etc.” passed. the current stock price. The algorithm I use is to ask Question: I know you are a whether the current worth of big proponent of Charlie the business is less than the year’s Berkshire Hathaway Munger’s Latticework of current stock price. If the Annual Meeting when he said Mental Models approach. answer is yes, there is no ques- that they made most of their How have you applied this tion that the stock ought to be money going long on a few thought process to invest- sold. On the other hand, even great businesses. Buffett has ing? if I made a mistake, but the ventured into all kinds of de- current value of the business is rivatives or pair trades, or Well, I think that Munger’s still above the current stock shorting, etc., but clearly he has mental models approach is a price, then I will typically wait made most of his money by very powerful construct. First for two or three years from being long on great businesses. of all, he talks about the notion the time I bought before I I think that the math on short- of worldly wisdom. He en- would think about selling. I’ll ing is very bad. courages folks to read and give the market some time to learn about things that are try to close that gap. First of all, in general, over very outside of the theme of value long periods of time, markets (Continued on page 6) Page 6

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(Continued from page 5) tion, but you don’t have much Let’s say you go to see a movie investing or might not seem to of an upside either. Both ways and you pay $10 to buy a have a connection to value you are a loser. Most of the ticket. Every seat in the thea- Professor Bruce investing, but I think it is very times that I see people pitching ter is occupied – the house is useful to know the way the an idea, I usually see them talk- full. Suddenly, the smoke alarm Greenwald world works. Reading books ing about 65 – 75 cent dollars goes off in the middle of the on science, economics, or and I think that those ideas movie and as smoke begins to Bruce C. N. Greenwald other different disciplines and tend to be lacking on two fill the theater, people run for holds the Robert Heil- to have a basic understanding fronts: There isn’t enough of a the exit. Now, this movie brunn Professorship of of all of these different disci- margin of safety and there isn’t theater has special rules, and Finance and Asset Man- plines is useful to the investing enough of an upside. the rule is that you can only agement at Columbia process. I think investing in leave the theater as long as you Business School and is general is one of the broadest “Many times, when I find someone from outside the the academic Director of disciplines that one can go into, theater who will take your because any stock you look at ticket and seat. You must en- the Heilbrunn Center hear about a stock is affected by so many different ter into some type of transac- for Graham & Dodd variables. Many of these vari- idea from another tion where that person pays Investing. Described by ables touch on subjects that are you for your ticket. So the the New York Times as outside of investing and finance. investor, the idea be- question that comes up is at “a guru to Wall Street’s So it is very useful to have a what price will that $10 ticket gurus,” Greenwald is an broad set of frameworks and ing presented does sell for now that there is this authority on value in- tools to draw on. I think it is alarm and smoke in the thea- vesting with additional very useful to basically become not seem to have the ter, and the answer is that it expertise in productivity a person who is strong on probably doesn’t sell for very much, or you might have to and the economics of worldly wisdom. margin of safety ten- give it away for free, or you information. Question: You are a fre- ets. I generally find may even have to pay the guy quent speaker at many to take it off of your hands. events, such as the Value margin of safety to That theater is the New York Investing Congress, where Stock Exchange, because on you get to hear many in- be the weakest part the stock exchange every share vestors pitch their favorite of any business is owned by ideas. What are some of of most ideas. ” someone at all times. If there the biggest mistakes you is an event which is a distress- see investors, especially ing event for a company which younger investors, making? leads people to say I no longer Question: We were fortu- want to own the stock, that is Many times, when I hear about nate to have heard you like the smoke in the theater a stock idea from another in- speak in Professor and people wanting to exit the vestor, the idea being pre- Greenwald’s Value Invest- theater. The person who you sented does not seem to have ing Seminar, where you want to sell the stock to, which the margin of safety tenets. I used an analogy about is the person who wants to generally find margin of safety smoke-filled theaters and enter the theater, has access to to be the weakest part of most spectacular waterfalls. Can the exact same information ideas. There is a very impor- you discuss this concept? that you do. He also knows tant thing about Ben Graham’s there is smoke in the theater. idea of margin of safety which I was recently discussing this Therefore, for him to still be is that the higher the margin of concept with a bunch of value willing to buy it, the price at safety, the lower the risk, investors and they all said they which the transaction takes which is obvious. The second never heard Buffett use this place, is likely to be a significant tenet is that the higher the analogy, but I could swear that discount at what the stock was margin of safety, the greater I heard it from Buffett. So for trading at before the smoke. If the return. If you are buying now, I will continue to say that you enter selected smoke-filled something that is a 70 cent I got it from Warren Buffett. theaters, and you later find that dollar, not only do you not the smoke is really nothing to have much downside protec- Here is the basic concept. (Continued on page 7) Volume II, Issue 2 PagePage 7 7

Mohnish Pabrai (continued from page 6)

(Continued from page 6) is no data other than news of worry about, or it has been put the 200 agents. That is clearly The real world usually is not out, then there is a chance you a theater with an alarm going that accommodating. You may have gotten a great investment off, with all kinds of smoke in it. have to look at situations, like and you can do quite well with The people sitting watching the Ben Graham did, where he it. movie had signed up for this focused more on the hard as- high-growth, high-momentum sets, and not much on manage- “As a value The second part of this is when stock, and they had signed up ment, etc. So, I have had some you have smoke in theaters, to see a certain kind of movie. very successful investments in investor, you don’t you are going to have these When the federal agents businesses where the bet was huge collapses in stock prices. showed up, they could clearly based on hard liquidation value, want to enter every If you look at the stock’s chart, see that this is not the kind of and I did not spend a lot of these will look like a waterfall. movie they want to see. They time assessing the quality of smoke-filled So what this means is that don’t want to be hanging management, other than that smoke-filled theaters are likely around with all the smoke and they were competent. theater. What you to lead to spectacular water- they want to leave. When they falls. As a value investor, you try to leave the theater, they There are other businesses want to do is don’t want to enter every needed to sell those tickets to where the quality of manage- smoke-filled theater. What someone else and the clearing ment is more critical, because carefully analyze you want to do is carefully price that they exchanged their of the nature of the business. I analyze these smoke-filled thea- Wellcare tickets for was $20 a was recently looking at the these smoke-filled ters to try to find one where share. This was 50% of just the stocks I’ve held the longest at the smoke is not real, or the cash on their balance sheet. Pabrai Funds. There are some theaters to try to fire alarm is not real, it went off Forget about the business, the stocks that I have held now for for no reason, and then buy earnings engine, and everything 5 or 6 years. I looked at these find one where the those tickets at hugely dis- else; people were not even stocks and I asked what about counted prices, then sit back willing to pay for the hard as- these companies has kept me in smoke is not real, or and watch the rest of the sets of the business at that these businesses for so long. In movie. point – not even the liquid many cases they are up two, the fire alarm is not assets of the business at that three, or even four times I think this is a good way to point. So you got a very spec- where I bought them and I still real, it went off for summarize the framework. tacular, real-world case of logic believe they are undervalued, One example I spoke about at going out the window, just and still hold onto them. The no reason, and then Columbia was Wellcare (NYSE: because of the stampede out of reason is, universally, because WCG). I generally don’t talk the theater. of the quality of management. buy those tickets at about stocks that I own, but I felt that Wellcare was such a Question: What impor- What I have learned to appre- hugely discounted pure textbook example. I tance do you place on as- ciate, when I looked back at couldn’t come up with a better sessing management when that nuance - historically, I have prices, then sit back example, even looking at the you make an investment? not paid that much attention to history of stocks. I also think the jockey. But I have learned, and watch the rest people learn a lot more with The jockeys are very impor- sometimes very painfully, that Ben Graham’s technique of tant. It depends on the situa- jockeys are much more impor- of the movie.” talking about current stocks tion. I think that the ideal tant than I had given them since they can relate better. situation is to have a business credit for in the past. So going Here is an event that is still that is a great business, which is forward I care a lot more playing out; there is still some going to grow a lot in the fu- about jockeys. I’m not always smoke in the theater. ture and not require much able to find great jockeys along capital. The best example of with great businesses that are Wellcare is a situation where something like that is Moody’s also undervalued, but I have you have a company that is – a great business, growing a learned to appreciate the im- trading at over $120 a share lot, that you can buy at a very portance of jockeys. when 200 federal agents show cheap price – well below its up at their doorstep, unan- worth and run by a spectacular One thing I would say is that if nounced, holding search war- manager. That is utopia, and you take a look at three classic rants. The stock is halted and that is what you always want to value managers: Longleaf Part- when it resumes trading, there try and look for. (Continued on page 8) Page 8

Mohnish Pabrai (continued from page 7)

I think that the best thing to do is to actually set up a small portfolio of your own and start making real investment bets. Don’t run these virtual portfo- lios – take real money that you actually have, and invest it like you would invest a $5 million portfolio. Be rigorous about it because I think you learn when you make mistakes that actually cost you money. From my point of view, that is the best way to learn.

Going to Columbia is a great idea! If you are already at Co- lumbia, follow Buffett’s advice and try to find a shop that is run by people you admire and have principles you believe in, and try to convince them to Mohnish Pabrai, Warren (Continued from page 7) about jockey bets. Most of bring you on board without Buffett (’51), and Guy Spier ners, Third Avenue, and Fair- their portfolio is invested in focusing on compensation. holme - all three are value people who are great jockeys. managers, but all three have They have large positions in Thank you, Mr. Pabrai. very different styles. Marty Leucadia, Berkshire Hathaway, Whitman of Third Avenue and Canadian Natural Re- -G&Dsville cares very much about hard sources. If you start to look at assets and he doesn’t care as why they bought these busi- much about things like fran- nesses, it is all about the chise value, or moats or even jockey. management. He cares the most about hard assets. If you When I look at Pabrai Funds, I look at someone like Longleaf, think of it as a blend of the they care a lot about the fran- three, because I have made chise. They focus on the en- many investments which are during moat, franchise, etc. very much Third Avenue-type One time they mentioned that bets – pure hard-asset plays. I they thought that Coke bot- have also made investments tlers were a great business, and where it is about the franchise they went looking around the value, moats, brands and so on world making a list of every – a Longleaf play. I have also Coke bottler on the planet, made several jockey bets, like trying to see which ones they Fairholme. I would say that could invest in at decent prices. over the past 12 months, I have In general, they focus on the learned to appreciate and business and the valuation, but spend more time analyzing the not as much on the manage- jockeys and put more weight ment. Their focus is more on on it. moats and franchise value, which is what you will see if Question: What advice you look at Longleaf’s portfolio. would you give to MBA Then, if you look at someone students who aspire to a like Fairholme, they are all career in investing? Volume II, Issue 2 Page 9

Annual Alumni Reunion with Joel Greenblatt

On April 28, 2008, current multiple does that lead you to? students and alumni of the What multiple does a company Value Investing Program were deserve in normal times and invited to the annual spring what kind of a discount does reunion at the Columbia Club that mean a stock is currently in Manhattan. In his introduc- at?” Greenblatt’s bet is that a tion, Professor Bruce turn in the market will come, Greenwald proclaimed that he just doesn’t know when. By speaker Joel Greenblatt has focusing on normal earnings, an achieved “the trifecta: he is a investor can create what Bill terrific investor, he has written Miller calls Time-Horizon Arbi- terrific books, and he is a terri- trage. “There are guys who fic teacher in the Value Invest- can trade short-term, and bang ing Program.“ out huge returns every month, Professor Bruce Greenwald moderates a Q&A with Pro- but (a) I’m not one of them; After reading his first book, You and (b) you are likely not one fessor Joel Greenblatt at the Columbia Club. Can be a Stock Market Genius, of them either!” quipped one might naturally wonder if Greenblatt. Greenblatt, the concepts of things were different when value investing aren’t very com- Professor Greenblatt began as Professor Greenblatt suggests plicated; however, they are a professional investor. “Was that investors focus on finding difficult to put into practice. It it more of the Wild West 25 areas that are ripe for mispric- is imperative that one maintain years ago?” asked Greenblatt. ing. When economic forecasts discipline in the face of every- “Now we keep producing all are bleak, people worry, and in thing going on. Assumptions these smart guys out of MBA turn, misprice securities. may have been too optimistic schools who are doing all this “Their outlook may be right,” over the past few years, but research and maybe those effi- says Greenblatt, “but this isn’t investors need to adjust their “The concepts of cient market guys were right. where I focus when investing. I valuations based on what they There are no opportunities focus on normal earnings think normalized is now. value investing left…” However, Professor power and a long-term normal Greenblatt pointed out several environment.” According to Professor Greenblatt suggested aren’t very reasons to be optimistic. First, Greenblatt there are a lot of that “…the best thing to differ- the internet bubble wasn’t so opportunities right now. entiate yourself in the process complicated; long ago. Second, in 2002 – is not just by doing the good 2003 there were some of the Next, investors should be try- work, but by having the disci- however, they are best bargains in the market that ing to figure out what the com- pline to not buy something just he had seen in many years. panies they are looking at are because you did the good difficult to put into Third, credit markets, which likely to earn in a normal envi- work.” Investors need the are much bigger than the stock ronment. Whether that nor- discipline to recognize when a practice…” market, were insane just about mal environment returns next company they have been work- a year ago. All this points to a year, or a few years from now ing on is not selling for the market that is not efficient. is unknown; but investors need same discount as they have to make sure that whatever seen in the past and pass even The longer Greenblatt has they are buying is at a big dis- if it is just a ‘little bit’ cheap. “If been in the business, the more count to that value. But how you are extremely disciplined, institutionalized he has seen it should an investor think about only buy when you have a large become. “Money managers normalizing earnings, on a long margin of safety, and are willing have different directives – and term basis going forward, when to stick it out for two or three now people only care how you the last 8 years or so of back- years - then I think you have did last month. If you beat the ward data for many industries the right process.” benchmark this month or next might be inflated? One thing to month, and more people be- look for is whether margins “I wait for easy ones,” admitted come focused on that, then less were higher over the past few Greenblatt. “I wait for ones people can focus on what nor- years than they were on a long- where I say ‘hey, if someone mal earnings power should be term basis. That analysis would would have looked at it this in a normal environment two go into your normalized num- way, it is clearly cheap’.” This to three years out, and what ber. According to Professor (Continued on page 15) Page 10

Annual Pilgrimage: CBS Students Meet With The Oracle Of Omaha

generation of his family to run Financial weapons of mass the company, which was destruction founded by Rose Blumkin in 1937. The purchase of Ne- Although he has been warning braska Furniture Mart is the the markets about the dangers stuff of Berkshire legend. And of derivatives and structured though Nebraska Furniture products for years, Mr. Buffett may not contribute as much as appeared to experience no joy Geico to the bottom line, there in his recent vindication. He is no question that this business noted that his primary con- is a quintessential WEB invest- cerns about derivatives involve ment. It is a business that is run the leverage they allow partici- by honest, hardworking people pants to employ, and the who could quit at any time, but opaqueness around their true don’t because they love their value. jobs. On the plus side, Mr. Buffett By noon, we had taken the full noted that there are often CIMA Co-Presidents Del “This is a difficult market. Re- tour of Nebraska Furniture and significant mispricings in deriva- Anderson (’08) and Matt cently I heard the story of an were ready to pepper Mr. Buf- tives which create opportuni- Loesch (’08) pose with investment banker who had to fett with as many questions as ties to profit. On the minus Mr. Buffett tell his wife that there would he’d let us ask. The Q&A ses- side, “derivatives present big be no bonus this year. He says, sion lasted for over two hours opportunities for financial mis- ‘We’re going to have to cut and began with a question chief. When we purchased Gen back. If you could learn to about Mr. Buffett’s thoughts on Re, there were 24,000 con- cook, then we could fire our derivates. tracts on the books. One con- chef.’ To which she replied, ‘If tract went out 100 years!” said you could learn to make love, Buffett. then we could fire the gar- dener!’”

And so began Warren Buffett’s opening remarks to a group of students from Columbia Busi- ness School and the University of Texas A&M on March 21 st at the Omaha Field Club in Omaha, Nebraska.

The trek to see the Oracle began early the night before with nearly 120 of Professor Greenwald’s students meeting at 116th and Broadway at 3:30 am. From there, two buses arrived and brought us to JFK airport, where we boarded a chartered Jet Blue plane at 6 am.

The group arrived in Omaha at 9 am and proceeded to a Berk- shire-owned subsidiary, the Nebraska Furniture Mart, where we were greeted by Bob Adam Lindsay (’09) listens as Warren Buffett (’51) answers Batt. Mr. Batt, the CEO of questions posed by students of Professor Greenwald’s Value Nebraska Furniture, is the third Investing Seminar (Continued on page 11) Volume II, Issue 2 Page 11

Annual Pilgrimage: (continued from page 10)

(Continued from page 10) ceedingly favorable terms in the It was in this context that he deal. Buffett countered this remarked “the CEO should point with the following obser- also be the head of risk man- vation: Just as stocks often pop agement for any major financial when people find that Berk- institution. I personally handle shire is buying, they also fall all of our derivative contracts. when Berkshire is selling. However, it is now obvious to Would you buy a stock that all of us that most banks, insur- Mr. Buffett didn’t want? To ance companies, and asset man- make up for the discount Berk- agers are not run this way. shire receives when selling— Back when we were running and to compensate for the Salomon, my partner Charlie long-term commitment it found a large number of mis- makes—Berkshire often needs takes in one of the derivatives to demand excellent terms to contracts. We paid Arthur justify a deal. It is also worth Andersen millions of dollars to noting that Mr. Buffett received review the contracts for us, a salary of $1 and is widely without someone asking how Columbia Business School and yet they had missed it. credited for keeping Salomon he values a company. This visit Professors Michael Johan- These things are designed to out of bankruptcy. As he said, would be no different – but the fool. They fooled the account- “I think they got their money’s question focused on the valua- nes and Tano Santos ants, but they didn’t fool Char- worth.” tion of international companies along with Mr. Buffett lie!” in particular. The Oracle com- U.S. trade deficit pared the valuation of compa- Salomon Brothers nies to how he used to handi- Mr. Buffett described our trade cap horses. “At the race track, Mr. Buffett’s discussion of de- deficit as the U.S. force feeding the first thing you want to do , rivatives at Salomon Brothers the world $2 billion in U.S. all things equal, is determine provided a nice segue for a paper every day. “It is kind of each horse’s chance of winning question about the famous deal like eating an extra roll for the race. Then you figure out in which Berkshire purchased dinner every night – it’s not which one has the best odds $700 million of preferred con- like you get up from the table relative to its chance of win- vertible stock. The question, and suddenly people say, ‘Oh ning.” This is the exact ap- akin to asking a chess grand- my god, you’ve gotten fat!’ But proach he took to valuing Pet- master what moves he would over time, of course, it has roChina. Mr. Buffett remarked use on himself, asked whether consequences.” that when he first looked at the he would have done the deal company he thought it was had he been in Salomon’s He also noted that accompany- worth about $100 billion. But it shoes. Mr. Buffett’s answer ing our deficit are some policy was only selling for $35 billion highlighted the benefits and decisions that could prove in the market at the time. As pitfalls that he experiences as a problematic. China has accu- he said: “That got my atten- long-term investor, and as one mulated foreign exchange re- tion.” While he freely acknowl- considered by many to be the serves of $1.5 trillion. Yet edged that investing in China is greatest of all time. when they tried to take some not quite like investing in the of those funds and purchase a U.S., Buffett maintained that Initially, Buffett explained, third-tier oil company, Unocal, PetroChina seemed to be trad- Ronald Perelman had indicated “Congress went ape.” Forcing ing at a “significant discount for interest in buying Salomon – other countries to take our one of the world’s largest oil but John Gutfreund was un- money and then not allowing companies.” In such a way, happy with the prospect of them to spend it as they wish Berkshire was able to scoop up selling to someone with a repu- does not seem sustainable, shares of PetroChina with a tation for financial engineering. Buffett claimed. significant margin of safety. In Berkshire clearly had no inter- general, Mr. Buffett explained est in buying it, levering it up, Valuation of international that he takes the same ap- and selling – so the firm be- companies proach to evaluating foreign came a very attractive candi- companies as he does domestic date. Second, it has been ar- A Q&A session with Mr. Buf- ones, but he requires an extra gued that Buffett received ex- fett would not be complete (Continued on page 12) Page 12

Annual Pilgrimage: (continued from page 11)

(Continued from page 11) even an MBA could under- to Korea. Management could measure of undervaluation to stand, Mr. Buffett described the be crooks for all I know, but if compensate him for potential financial crisis in the following you buy 10 or 20 of these com- unknowns. way: “Banks got into trouble by panies, you can’t lose money. passing around this toxic Kool - You can find these investments Of course, as any value inves- Aid, like Jim Jones. And then today, but you may have to tor will tell you, a huge compo- they drank a couple of gallons look in places like Korea.” nent of valuation is understand- themselves.” ing competitive advantage. Lesson from past crises When asked about how he Other people’s money assesses a company’s competi- On the topic of managing tive advantage, Mr. Buffett One CBS student displayed an money, a student asked about Students present Mr. Buf- walked us through numerous interest in starting his own firm Mr. Buffett’s thoughts on les- fett with a Yankees Jersey examples including See’s one day and asked Mr. Buffett sons learned from past crises bearing the year he gradu- Candy, Coca Cola, and Snick- how he knew he was ready to such as 1973-1974 and 1989- ated from Columbia Busi- ers. This discussion can be manage other people’s money 1990. Mr. Buffett reminded us ness School summarized succinctly with at such a young age. Mr. Buffett that the “stock market is there Buffett’s first eight words: “If it recalled that he left Columbia to serve you, not to instruct isn’t obvious, I don’t buy it.” when he was 20 years old and you. The volatility in a stock is became a stock broker in your best friend! I love it when Banks and the financial Omaha. His first call was to his companies’ prices jump up by crisis Aunt Alice, to whom he sold 100 percent or down by 50 100 shares of Geico. Buffett percent in the same year. Vola- “Banks got into Not surprisingly, the current remarked that some of the tility in stocks is what has made turmoil in the financial markets other calls weren’t so easy. “I me rich!” He further instructed trouble by spurred one student to ask Mr. was always comfortable doing us to be “detached from the Buffett his thoughts on Citi- things with my own money – market emotionally, but pay passing around group and the other money- that was never a problem. But I attention to opportunities as center banks. Acknowledging was bothered when others they arise.” all of our concerns, he re- bristled at the price action on a this toxic Kool- marked that “Citi will be stock or investment I had rec- A turnabout on turn- around in the future. You have ommended. It was difficult for arounds Aid, like Jim to think that when the Fed me. People would worry if steps in to save number five Geico lost 50 percent, but I Some of us in the audience Jones. And then Bear Stearns, they will print would just buy more.” apparently are not patient money if they have to in order enough to wait around for the to get the big banks through.” Acknowledging Ben Graham’s market to throw them a “fat they drank a More interesting, perhaps, was influence on him, he said that pitch.” One student asked how Mr. Buffett betrayed his “after I met Graham, I felt 100 about Mr. Buffett’s thoughts on couple of financial sophistication when percent confident that I was turnaround situations and discussing the possibility of doing the right thing. So the noted that Buffett had been bankruptcy in the financial mar- key was getting my investors to involved in quite a few when he gallons kets. Although decrying the agree to the partnership rules, was younger. Mr. Buffett ex- abuse of derivatives, Mr. Buffett and they did.” Mr. Buffett went pressed a different sentiment themselves.” is unquestionably savvy and will on to describe how he used to now perhaps because of Berk- look just about anywhere for comb through the giant securi- shire’s current size or because mispricings. “It is interesting if ties manuals published by of the evolution in his invest- you look at the credit default Moody’s or Standard & Poor’s ment philosophy. “If you are swap market, which is essen- looking for value. Recently he good at turnarounds,” he said, tially the cost of insurance tried a similar tact when he “you are probably just a good against Citigroup defaulting on bought a manual for securities manager. Go join a good busi- its bond obligations, it is imply- and companies in Korea where ness and you will probably do a ing a 3.4% likelihood of default. he quickly found dozens of lot better. Why try to swim I think that is wrong.” companies selling for two and against the tide? If you want to three times earnings: “I had build a good reputation, buy a Showcasing his knack for never heard of any of these good business. I can’t think of evocative analogies and imagery companies, and had never been (Continued on page 13) Volume II, Issue 2 Page 13

Annual Pilgrimage: (continued from page 12)

(Continued from page 12) one person who has been re- peatedly successful at turn- arounds. Capitalism can be brutal when you are up against competition that has some advantage over you.”

Students, managers, and investors

The conversation took its final turn toward three constituen- cies in which Mr. Buffett has a lot of interest: students, manag- ers, and investors. Commenting first on his advice for students, Mr. Buffett highlighted the culti- vation of accounting and com- munication skills. “Get as much accounting as you can,” he explained, ”it is the language of business.” In addition to accounting, he stressed the you can sell to a private equity has the best track record. You importance of written and shop, which is like selling to a Professor Bruce Greenwald need to spot great investors verbal skills and pointed out porn shop. They will buy the and Warren Buffett (’51) when they are young and un- that “the only diploma I have company and they will want to known.” Nevertheless, as great hanging up in my office is from adjust a few things, make the as it is to find investors before the Dale Carnegie School for boobs bigger, and so forth… It they are famous, he reminded public speaking. I joined 30 will sit on the shelf for a couple us of the difficulties in managing people every week to work on of months, and then some guy large sums of money. Although public speaking. It changed the in a trench coat will come he thinks funds like Sequoia and course of my life. Also, I think along and buy it from them.” Baupost will do better than writing is extremely important. average, these funds will strug- If you can get ideas across to Once the laughter in the crowd gle to do as well as they did other people, you will stand settled down, we left Buffett when they were smaller. out anywhere you go.” with a final question: “which

investors would you recom- Although he discussed what he mend today?” Although he was Striking a pose looks for in a manager in some able to tick off a few names, After a few concluding re- detail, it boils down to one such as Greg Alexander at marks, Mr. Buffett accompanied word: “passion – they’ve got to Ruane, Cunniff & Goldfarb and us outside where we partook want to do the job.” In perhaps Seth Klarman at Baupost, Mr. in yet another Buffett trip tradi- his most colorful analogy of the Buffett focused more on how tion: pictures with the Oracle day, Mr. Buffett described the we should think about finding himself! It is quite a sight to type of managers he’d buy a these great investors. When he behold to see 120 professional business from: “We don’t do closed his partnership in 1969, and successful adults swarm auctions. Owners who auction he recommended Sandy Got- around Mr. Buffett like so many their business don’t care about tesman and Bill Ruane. He fifteen-year-old girls at a Justin what happens to them. They knew them well, knew their Timberlake concert. But War- don’t think of it like a painting. temperaments, and knew they ren took it all in stride and When you sell your business, would pursue sound strategies patiently took photos until you have two options. Sell to (for more on this topic, see every camera had run out of Berkshire and it is like selling Buffett’s article: “The Superin- your painting to the Metropoli- vestors of Graham and Dod- memory tan Museum of Art. We will desville). He also noted that, “I put up a wing for it. Otherwise wouldn’t pick the person who -G&Dsville Page 14

Squaring Off Against a Hedge Fund Master

charitable giving. As an manageable level. The judges added incentive, Ack- pressed further: “Do they own man pledged to donate or lease their stores? How $25,000 to Columbia much do they pay in rent?” In Business School on each case, Chen responded behalf of the student calmly with an impressive com- with the most promis- mand of the facts, and the pan- ing investment thesis. elists offered suggestions for how she could improve her Students spent months thesis. preparing for the con- test. After a series of Next, Vikas Jain shared his five training sessions views on database marketing spanning February to firm Acxiom Corporation, April, students submit- which he believed is “a good Judges of the 2008 Announcing the 2 nd Annual Per- ted two-page summaries of business run badly.” Jain pre- Pershing Square shing Square Value Investing and their investment ideas to a sented a series of steps man- Challenge included (l Philanthropy Challenge selection committee, which agement could take to increase to r): Professor consisted of recent graduates the firm’s stock price. Again, Bruce Greenwald, For many investment profes- from Columbia’s Applied Value the judges asked questions to Danilo Santiago, Bill sionals, making money in the Investing program. Five finalists better understand the risks and Ackman, Ali Namvar, stock and bond markets is the – ‘09ers Amy Chen, Vikas Jain, assumptions behind Jain’s the- ultimate challenge. For those Adam Lindsay, Shilpa Marda, sis, inquiring about whether and Ken Shubin-Stein who succeed, an additional and Stephen Walker – were their technology was proprie- (arguably no less formidable) selected to present their ideas tary and about the presence of challenge can be finding mean- to a star-studded panel of a competitive advantage. ingful and effective philan- judges: thropic activities. Bill Ackman, Adam Lindsay continued the Founder of Pershing Square • Bill Ackman – Founder challenge by advocating a long Capital Management, noted this and Portfolio Manager, Per- position in used car retailer “high-class problem” in his CARMAX. His comments dem- introductory remarks for the shing Square onstrated a thorough under- first annual Pershing Square • Ali Namvar – Senior Ana- standing of the business, em- Value Investing and Philan- lyst, Pershing Square phasizing its strong competitive thropy Challenge, which took Danilo Santiago – Founder position and potential expan- th • place in Uris Hall on April 25 and Portfolio Manager, Rational sion opportunities. In the Q&A portion, the panelists asked a 2008 . Asset Management series of detailed questions Ackman’s own experience with • Prof. Bruce Greenwald - about the company’s financing business school, he reflected, Robert Heilbrunn Professor of business and receivables. One was “a lesson in due diligence.” Finance and Asset Management judge suggested that a sensitiv- He followed in his father’s • Ken Shubin-Stein - Value ity analysis of customer default footsteps and attended Har- Investing Program Adjunct rates would be helpful. The vard Business School, which – Professor judges also inquired about po- much to his chagrin – did not tential threats from nontradi- offer classes in investment The final presentations began tional competitors, such as management. To provide addi- on Friday morning, April 25 th . eBay. tional training opportunities for First, Amy Chen presented her students of investing, Ackman thesis on retailer Limited Shilpa Marda made a compelling worked with Columbia’s Heil- Brands. After a brisk five- case for NutriSystem, the brunn Center to create the minute presentation, the judges weight management system. Pershing Square Challenge, began peppering Chen with Her pitch included primary which has two objectives: to questions, starting with the research on potential competi- teach students how to develop balance sheet. Chen explained tive threats and a sensitivity and pitch investment ideas, and that the Limited had recently analysis of the firm’s marketing to give students exposure to restructured; debt was at a (Continued on page 15) Volume II, Issue 2 Page 15

Squaring Off... (continued from page 14)

tions focused on a number of spending. One of the judges key issues from regulatory complimented her research on pressure that could arise in a competitors but pushed for tough economy, competition more detail on the company’s from the trucking industry, and track record of returning cash a potential shift away from coal to shareholders. Marda re- given a new presidential ad- sponded with an easy com- ministration’s emphasis on new mand of the relevant facts. energy sources. Another panelist observed that Marda’s valuation was very After these spirited discussions, conservative—she could go the panel adjourned for several slightly higher and remain con- minutes to debate the merits of servative. In response to one each idea and select a winner. judge’s question on the impact In the end, the judges selected of a consumer recession, Ack- Shilpa Marda’s NutriSystem man interjected, “it costs $10 pitch. At a lunch reception that per day – that’s less than followed, Ackman presented Amy Wu, David Krasne, and Stephen Walker, members McDonalds! You can save the check for $25,000 to Co- of the Class of 2009, enjoyed the after reception where money and fit in your old lumbia Business School on the winner of the 2008 Pershing Square Challenge was Marda’s behalf and lingered in clothes.” announced. See Shilpa Marda’s winning pitch on the order to chat with students. Finally, Stephen Walker pitched next page. CSX, a provider of rail-based Attention future hedge fund transportation services. In his impresarios: do not miss this McDonald (smcdonald09@ opening remarks, Walker year’s Pershing Square Value gsb.columbia.edu) or Priyanka pointed out that CSX benefits Investing and Philanthropy Agnihotri (pagnihotri09@ from a combination of growing Challenge! The first training gsb.columbia.edu), VPs of edu- demand and tight capacity for event – Competition Analysis cation and mentoring for the coal, which “has to go by rail.” and Valuation I – begins on Columbia Investment Manage- th As a former employee, Walker September 26 at 10:00am in ment Association. displayed a wealth of knowl- Uris 301. For more informa- -G&Dsville edge about the business. Ques- tion, please contact Sean

Joel Greenblatt (continued from page 9)

(Continued from page 9) some of the smaller situations. Addressing the 2009 graduates way, Greenblatt does not have This is where younger inves- of the Value Investing Program, to make much in the way of tors can excel. One piece of Professor Greenblatt agreed predictions or have to base his advice he would give to inves- that for those who have not whole thesis on normalized tors who are just starting out, yet found a job, the economic earnings. “I look for something especially if they are starting situation sounds like bad news; any idiot would buy if they their own fund, is to avoid “but you don’t really want to were looking at it in the same investing “like you are running start working at a time when way that I was.” $20 billion if you are running things are at all-time highs,” $20 million… Look at some of Greenblatt asserts. This is Professor Greenblatt thinks the situations that some of the actually a much better environ- young managers will always bigger guys aren’t looking at. ment, if you can find a job., he have an advantage in the busi- Do your own work. You don’t says, concluding that “it is a ness, whether it is value or have to be as smart as guys harder time to find a job and a special situations, because the that have been doing this for better time to get one!” investors who have success in twenty years, because there these areas make a lot of are situations the older guys -G&Dsville money and become too big for just can’t look at anymore.” Page 16 The Winning Pitch: NutriSystem Inc.

Shilpa Marda The following section includes a reproduction of Shilpa Marda’s winning investment pitch from the Pershing [email protected] Square Philanthropy and Investment Challenge. Please note this information is dated.

NutriSystem Inc. Investment Thesis NutriSystem Inc. is a provider of a weight management system based on a portion-controlled, prepared- (NASDAQ: NTRI) meal program. NutriSystem utilizes a direct-to-consumer sales and distribution approach and out-

sources the bulk of production and distribution of its meals. This results in a business model with low Price: $18.93 capital requirements, high financial returns (ROA 53%), solid free cash flow, and high margins (gross Shrs Out: 29.56M margin 53% and operating margin 21%). Sales have experienced tremendous growth in the past few Market Cap: 559.60M years: 68% in 2004, 459% in 2005, 167% in 2006 and 37% in 2007. NutriSystem is primarily a sales and marketing organization with a highly scaleable business (revenue per employee increased from $268k in PE: 9.14 2002 to $836k in 2006). Since July 2007, the stock price has fallen from about $72 to $20 per share Yield: 3.7% (current) due to a 3 rd quarter and 4 th quarter earnings miss and new competitive threat from Alli, which 52wk Hi: $50.33 is the first FDA approved OTC weight-loss drug, introduced in June 2007. However, this competitive 52wk Lo: $12.55 threat has been misunderstood by the market and I believe NutriSystem will maintain its pricing power (implemented 15%, 3%, 4%, 2% price increases between 2003-2006) and benefit from a growing indus-

try, proven product efficacy, untapped markets and a strong fundamental business model. 52 Week Chart:

Investment Catalysts • Impact of Alli – Introduced by GlaxoSmithKline, Alli restricts the absorption of fat in the body, and has severe side-effects including increased bowel movement and oily spotting. Alli had 2M customers in 2007 since its introduction, resulting in NTRI falling short of new customer acquisitions by 40K in Q3. However, I believe this is a short-term shift in the competitive landscape, as Alli is not sustainable. Initially many people tried it, but did not continue to use it due to severe side effects, and weight gains after they stopped using the product. Alli sales according to GlaxoSmithKline (in British Pounds) were 76M in Q2 (with just 2-weeks of being on the market) 34M in Q3, 40M in Q4 and 9M Q1 2008, indicating the ‘faddish’ nature of this new drug. Before Alli was introduced, NTRI was trading at a P/E of 30X around June 2007. • Growth in Market Share – NTRI is positioned for growth in a number of areas: a) Men’s Diet (data as of 09/25/2008) Market – Implemented in July 2006 and represented 30% of the business at the end of 2006. NTRI provides a simple and private weight-loss solution, ideal for the men’s market. b) International mar- ket – Business model facilitates easy expansion through local partners/distribution. Canada launched in Q1 2008 and Japan, Australia, Germany and UK expected to launch in 2009. c) Seniors – Launched NutriSystem Silver in December 2006. Provides a simple solution to seniors with minimum hassle. d) Domestic – Only represented 1.9% share of diet market in 2007. Innovative product launches such as NutriSystem Advanced in 2008 (omega 3’s and heart-healthy meal pro- gram) will help increase share. • Stable Business with a Scaleable Model – As NTRI's client base increases, customer reactiva- tions (purchases made outside of the 9-month initial diet cycle) have gone up and in 2007 are ex- pected to represent over 12% of sales. Reactivations yield a net profit margin of 31% vs. new cus- tomers, who yield 15%. In 2007, new customers yielded gross margins of $373/customer and CAC of $173, yielding a profit margin per customer of $200. • Management buyback of stock and Acquisition Target – Management has board approval to buy back up to $200M of stock. Management also alluded to receiving calls from potential ac- quirers.

Industry Landscape and Competitive Advantage • In 2006, there were 62M dieters in the U.S. divided into the commercial weight loss market (approximately 10%) and self-directed (79%). This is expected to grow to 81M dieters in 2010 (30% increase). • The international diet market is on the rise with the spread of fast-food chains, increase in wealth and shift to less physically intensive work. According to WHO, in 2005, 1.1B people were over- weight. Volume II, Issue 2 Page 17

NutriSystem Inc. (Continued from previous page)

• Increasingly busy lifestyles and growing use of the internet are condu- cive to NTRI’s model of a convenient web-based weight loss solution. • Also, in addition to diet due to health risks, U.S. consumers are prone to images in media, fashion, and entertainment that depict thin as the ideal body type. • Main competitors are WeightWatchers (center-based), Medifast, Jenny Craig (center and direct), eDiets.com (direct – caters to a less price sensitive customer), and self-administered products such as Atkins and South Beach diet and medically-supervised programs. • NTRI targets the price-sensitive consumer who wants a simple-to-use weight-loss program, but is also used by customers that would not be considered price-sensitive. This is a large market as the majority of overweight people are in the less affluent segment of society. • While barriers to entry appear to be low, it is interesting to note that other entrants into the online diet market have not been successful. This indicates that NTRI does enjoy barriers to entry, including cus- tomer captivity and cost efficiencies.

Primary Research • Surveyed doctors and pharmacists as a potential Alli consumer. 80% told me they would not recommend the drug, and 20% were neutral, focusing more on the medical aspects. They said the side-effects are very extreme and involve changing your lifestyle to adapt to them. They also said the “results are not that good anyways, if you read the small print.” One pharmacy had to send back their stock of Alli as inventory levels were too high due Bill Ackman and Shilpa to weak demand. Marda (’09) • Spoke with people in healthcare field about weight-loss drugs and found out that typically there is an initial hype with weight-loss drugs, and then demand tailors off as side-effects occur and weight comes back. • After reading internet diet blogs and surveying people who had actually used or tasted NTRI, I got very positive feedback. People thought it was an extremely simple system that works. They liked the taste of most of the foods and enjoyed the variety. The major drawback was that people wanted to eat out occasionally and other similarly minor issues.

Valuation • Average P/E of peer group is approximately 14x earnings. In my base case scenario, I have assumed multiple expansion to 13X and an EPS of $3.41 (NTRI repurchased 10% of shares O/S in Q1 2008) (15% YoY growth). This results in a price target of $45. • A discounted cash flow analysis with conservative sales growth estimates and terminal growth of 3% and WACC of 13% also yields an intrinsic value of close to $45. • Employing an Earning Power Value approach, and adjusting for normalized 2007 earnings, depreciation and capex with no growth, yields a price of $28, which represents an estimate of downside risk. NTRI requires very few assets to generate revenue. I came up with a net balance sheet reproduction value for NTRI, including marketing expenses incurred over the past few years as though they were capitalized at $365M. This indicates the existence of a franchise, as the normalized EPV of the firm is $895M. I believe NTRI enjoys barriers to entry and will be able to grow profitably within its franchise over the next few years.

Risks • NutriSystem may be subject to fluctuations in demand due to the diet industry’s vulnerability to changing fads • Increasing customer acquisition costs and weak consumer discretionary environment • Extended impact of Alli due to strong marketing efforts by GlaxoSmithKline Page 18

The 11th Annual CIMA Conference

avoid such down periods, but remarked that “you can really only do this with a computer.” Combining momentum and value requires bargain hunters to “ride the wave” – something that is hard for them to do. Pzena’s solution: Instead of avoiding these periods – prom- ise them! If your investors don’t like it, they can find someone else to manage their money.

Commenting on market volatil- ity and his investment frame- work, Pzena made the observa- tion that volatility occurs when investors pay attention to the marginal news instead of un- derstanding the entire fran- Panelists (l to r) Profes- On February 1, 2008, the Co- the bad periods?” chise. He went on to describe sor Bruce Greenwald, lumbia Investment Management his rigorous investment proc- Bill Miller (Legg Mason), Association, in conjunction He discussed three types of ess. The process, which with The Heilbrunn Center for stresses a formal valuation Lisa Hess (Lowes Corp) investors: momentum investors Graham & Dodd Investing, (who “ride the wave”), value framework, looks at stocks on and David Winters th sponsored the 11 annual Co- investors (who exploit emo- a normalized price-to-earnings (Wintergreen Fund) lumbia Investment Management tions), and savants (who pre- basis and focuses on the long- Conference. With students, dict the emotions). Mr. Pzena run underlying earnings power faculty, alumni, investors, and presented data going back to of the business. press in a packed Lerner Hall 1968 which suggested that a Auditorium, the conference did simple value strategy, based Concluding his remarks, Mr. not disappoint. solely on low price-to-book Pzena gave some insights on companies, and a simple mo- what it takes to be a value Dean Hubbard opened the mentum strategy, based on the investor: 1) A value investor conference with a few remarks. nine-month return, outper- has to be willing to invest when He first noted that “great in- formed the market. He noted, the outcome is uncertain; 2) If vesting is important for dy- however, that if you had used you need to know what’s going namic economies” and ex- the value strategy during this to happen, you’re not a value pressed his conviction that 40-year stretch, there were investor; 3) The only reason Columbia Business School is at eight years when you would stock prices get really low is the vanguard of the next gen- have lost 20%. In the grand because of uncertainty – al- eration of great investors. Fi- scheme, he remarked, these though you don’t know what’s nally, he was sure to thank the are blips – but did comment going to happen, you can try to conference organizers Jon that “when you’re losing 20%, size the risk/reward trade-off. Salinas, Qie Zhang, and Puneet it doesn’t feel very good. Cli- Kakar . ents begin to question you. Following Mr. Pzena’s speech You begin to question yourself. was the Real Estate Panel with Richard Pzena, founder of the And investors ask: ‘Wasn’t it Columbia Business School Pro- highly regarded Pzena Invest- obvious this was going to hap- fessor Chris Mayer, Pershing ment Management, which was pen?’” Square founder Bill Ackman, recently taken public, delivered and Pennant Capital founder the morning’s keynote address. He then posed the question: Alan Fournier. Professor Mayer His speech was directed to- “Can you avoid the 20% down began the comments by de- ward the question all value periods? Should you?” Mr. scribing the situation through- investors will have to deal with: Pzena noted the temptation to out the country and remarking “How do you make it through combine various strategies to (Continued on page 19) Volume II, Issue 2 Page 19

CIMA Conference (continued from page 18)

singling out Nestle. (Continued from page 18) banks -- and potentially good that “in some parts of the for foreign relations as well. country there are unheard-of Mr. Ackman said, “They’re not On assessing foreign manage- ment, Weiss stressed the need vacancy rates.” going to shoot us if they have money in our banks.” Ackman for humility and the need to demand higher return require- Addressing liquidity, Mr. Ack- expressed worries that foreign ments as well as “big boy” cor- man suggested that he “used to investors will be disappointed if porate governance. Jean-Marie think the Fed controlled the ultimately they lose money in Eveillard conveyed a skeptical supply of money – the rating The Heilbrunn Center for those bank investments. attitude towards management, agencies do it now by endors- Graham & Dodd Investing is a noting that he never meets ing structured products.” Mr. The second panel of the day premier knowledge center for with management until he has Fournier added that the futures covered the topic of interna- the practice and theory of done a lot of work because markets are implying lower tional value investing and in- investing. Building on Colum- then they need to be straight home prices over the next cluded Andrew Weiss, founder bia Business School’s re- with him. On a lighter note, several years – bringing us back of Scout Capital, Jean-Marie nowned history in value in- Mr. Eveillard made the com- Eveillard, portfolio manager of vesting and finance, the center to trend. ment that Wall Street’s the First Eagle International furthers new developments in “optimized balance sheets” The panelists continued to Value Fund, and Jeff Lee, a part- investing and imparts the aren’t so ‘optimal’.” original principles of Security discuss the role of the rating ner at Owl Creek. agencies, the banks, and the Analysis authors Benjamin Paraphrasing Warren Buffett, individuals in creating the sub- Responding to where the over- Graham and David Dodd. Jean-Marie Eveillard under- prime mess. Professor Mayer looked pockets of value might scored the importance of un- contrasted credit card securiti- be, Weiss suggested non-bank Pictured Above: Roger derstanding companies and zations with asset backed secu- financials, exchanges, and credit Murray and Robert Heilbrunn their managements: “When rities, noting the incentives are card processors. Eveillard com- rowing a boat, what matters is more cleanly aligned in the mented that there are world not how strong your muscles former. Mr. Fournier declared class industrial companies in are, but whether the boat is that “structured finance is Japan. And Mr. Lee suggested leaking.” For example, he ex- dead” and Mr. Ackman sug- Japan, China, and India with the plained, “stupid acquisitions gested that the rating process caveat that one needs to focus bother me more than excess be restructured so that the on management because you buyers of credits pay for the need to focus on how to close cash on the balance sheet.” ratings instead of the issuers. the discount gap. In the U.S. there are mechanisms for this, In the next panel, Bill Miller, Lisa Hess, and David Winters The panelists agreed that, over- in Japan there aren’t. Mr. Russo discussed their best ideas and all, the presence of sovereign noted that there are many offered advice to students pur- wealth funds will be good for excellent European companies, suing careers in investment management. Mr. Miller started with the point that often the best places to look are the areas that have done the worst – housing, financials, and con- sumer discretionary. He also pointed out that, historically, recessions happen 5% of the time and that if the Fed can’t predict them, there’s no point for us to try to predict them.

Lisa Hess suggested that the U.S. could offer some good opportunities and remarked that it used to be the emerging markets. Hess noted she espe- cially likes “financials with Professor Artie Williams (EMBA ’02), Jennifer Wallace (Continued on page 20) (MBA ’94), and Professor Bruce Greenwald catch up at the 11th Annual CIMA Conference Volume II,I, Issue Issue 2 1 Page 20

CIMA Conference (continued from page 19)

who do best are the ones who management. “Value investing” know themselves best.” And isn’t buying the cheap stocks of David Winters echoed: “Who bad businesses. gets rich? People who do solid fundamental work, have stable Mr. Loeb also offered the audi- emotions, and are long-term ence a look into the various investors.” Lastly, Bill Miller strategies Third Point employs – quoted Keynes: “it is the duty of including special situations, risk the long-term investor to en- arbitrage, and distressed debt. dure great loses with equanim- He walked us through his past ity.” investment in Dade Behring, a great but misunderstood busi- The conference concluded with ness. On the topic of special the Keynote address of Daniel situations and event investing, he Loeb, the founder of Third Point stressed the point that the stu- Capital Management. He began dents in the room should take his speech describing his early Joel Greenblatt’s course at Co- Bill Miller and Thomas forays into investing during col- lumbia – or at the very least (Continued from page 19) Russo catch up at the lege. Despite a quick and lever- read his book “You Can Be a 11th Annual CIMA moats around them and retail.” aged start, he ended up $7,000 Stock Market Genius (Even If Conference In contrast, David Winters is in debt to his father. He didn’t You’re Not Too Smart).” He focused outside North America pay this off until he was 29. also pointed out that although where he says you can get both Third Point does engage in activ- growth and value. He said he has Mr. Loeb then described the ism from time to time, it really is also taken an interest in the founding of Third Point with just a small portion of his port- stocks of luxury goods compa- $3,000,000, mostly from friends folio. nies – companies whose stocks and family. He suggested this have gotten “smashed.” Ms. was his best career move since Finally, Mr. Loeb left us with his Hess was generous enough to he was “unemployable” due to insightful comments on risk offer her “walk away from the his varied and eclectic back- management. He underscored markets for five years and sleep ground. “Luckily,” he observed the difference between net and well at night” portfolio to the dryly, “I was there to give myself gross exposure and – alluding to audience. a job.” Mr. Loeb stressed the the phrase, “love means never point that there is more to run- having to say you’re sorry” – Describing the types of compa- ning a hedge fund than just in- suggested that, “good risk man- nies he looks for, David Winters vesting. It is also managing a agement means never having to said he likes good businesses business and requires one to sell something you really like.’” with pricing power at a low think deeply about retaining, -G&Dsville price – he called this the attracting, and moti- “trifecta.” An added bonus is vating the best em- when management is “pulling the ployees. He urged oar in the right direction – that’s those considering a a beautiful thing – that’s how similar path to “give you get rich!” it some thought.”

Finally, the panelists were good Offering his enough to offer their career thoughts on invest- advice to the students in the ing, he said that room. Bill Miller told the eager value investing isn’t students that they “need an just analyzing num- edge” and need to know them- bers – there are a selves. He said the biggest ten- number of pitfalls dency he sees is that people get you have to be “very emotional.” He stressed aware of: value traps, liquidity Legendary value investor Jean- that the “environment where traps, catalysts, proper assess- Marie Eveillard answers questions you operate is very important.” ment of the business climate, from conference attendees Lisa Hess added that the “ones portfolio construction, and risk Volume II, Issue 2 Page 21

MBA Advice from the Oracle of Omaha

By David Kessler (MBA ’08) would last, he replied, “I don’t attention to salary. “Who you know. I have never made work for is extremely impor- money on macro calls.” Buffett tant, so choose carefully,” he On March 21 I flew to Omaha said that even if he had per- counseled, adding that the — along with 150 of my class- fectly predicted macro condi- most important decision of his mates — to meet Warren tions in 1973–74, he would not own career was going to work Buffett, MS ’51, a man I have have bought See’s Candies in admired (some friends would for Benjamin Graham. 1972 going into a recession and say fanatically idolized) for would have missed out on a close to 15 years. As MBA students, we are be- company that he has referred ginning our careers in an age to as “the prototype of a where the image of a corporate David Kessler (’08) and Warren After a tour of the Berkshire dream business.” executive has been bruised. Buffett (’51) Hathaway-owned Nebraska Spending time with Warren Furniture Mart, we were After joking that our gradua- Buffett — an astute business- brought to a room at the tion was not perfectly timed, man, a legendary investor, a Omaha Field Club. Warren Buffett warned that we should rational and disciplined person Buffett stood at the front — not be discouraged from pursu- and a generous philanthropist two of his five daily cans of ing a career in finance. Finance — afforded us the opportunity Cherry Coke nearby — and for is only going to become more to learn much more than just the next two and a half hours, important as time goes on, he how to pick stocks. answered our questions. said, and it is a field where one can truly stand out and be rec- Before the trip, I was certain The questions covered a wide ognized. that no one could ever live up range of issues, including what to the sincere, humble and he looks for in a business, the He advised MBA students to generous image depicted of him current financial situation, re- learn as much about accounting in books, shareholder letters cent events at Bear Stearns, as possible, adding that, and TV interviews. I was ethics, emerging markets, com- “accounting is the language of wrong. Even that lofty image modities, his relationship with business.” He also said that did not hold a candle to the Benjamin Graham and his typi- writing and verbal communica- man I was lucky enough to cal day. His answers were a tion are extremely important in spend half the day with in powerful reminder of his the business world and that unique ability to distill complex Omaha. students should seek out ways issues down to their bare es- to improve these skills every Originally posted to Columbia sence. chance they get. Business School ‘s Blog, “Public Offering” When asked about how long http://www4.gsb.columbia.edu/ Buffett urged students looking the current financial crisis publicoffering for jobs not to pay too much SAVE THE DATE

The 12th Annual CIMA Conference February 13, 2009 Columbia University - Lerner Hall

Past speakers have included: Jean-Marie Eveillard, Marty Whitman, Leon Cooperman, Steve Mandel, Daniel Loeb, Thomas Russo, Bruce Berkowitz, Rich Pzena, James Tisch, David Winters, Bill Ackman, and more...

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