ricky sandler eminence capital valueinvestorinsight-issue 80

As CFO of the then 12-person Gabelli& Co. in the early 1980s, BobRobotti got plenty of exposure to

the investment process – if not much inputinto the actual decisions made. “Let’s justsay Mario Gabelli didn’t need me to pickstocks,” he says.

Since starting his own investment firm in1983, Robotti’s record as a decision-makerhas been superb. Focusing on unloved orunknown smaller-cap stocks, he’s returnedan average 17.4% annually to investorsover the past 20 years, vs. 10.3% per yearfor the Russell 2000.

Great runs by the energy and small-capcompanies on which he focuses haven'tdiminished his ability to find values, he says:“Volatility will likely be up, but we’re find-ing plenty of things to buy.” See page 12

I N V E S T O R I N S I G H T

Robert RobottiRobotti & Co.

Investment Focus: Seeks ignored or temporarily struggling small-cap companieswith the potential to at least double theirshare price within three years.

ValueInvestor August 25, 2006

Quality ControlIt’s rare for great businesses in structurally sound industries to get relativelycheap. When they do, Ricky Sandler is quick to take advantage.

With a highly successful investoras a father, Ricky Sandler hasoften been tempted to join the

family’s investment firm. “My dad hasasked me something less than a 1,000times, but more than a 100, to come workwith him,” he says. “I've always wanted todo things on my own.”

Sandler’s independent streak has paidoff handsomely for his Eminence Capitalinvestors since he started the firm in 1999.Now with $3.2 billion in assets, Eminencehas returned 20% net to investors annual-ly, vs. a 2% annual gain for the S&P 500.

Sandler today sees particular opportunityin large-cap growth stocks. “When valua-tions are compressed and everything tradesfor 13-17x earnings, it's time to trade up forquality and growth,” he says. See page 2

Inside this IssueF E ATU R E S

Investor Insight: Ricky SandlerSeeing bright future prospects for Cisco, Applied Materials, Oracleand Arbitron, but clouds on thehorizon for Lexmark. PAGE 1 »

Investor Insight: Robert RobottiFinding eclectic mix of unrecognized value in shares of Atwood Oceanics,Drew Industries, Zenith Nationaland Pre-Paid Legal. PAGE 1 »

Special: SuperInvestor InsightOur new publication, tracking theactivity of the world’s best investors:

� Up Front PAGE 19 »� What They’re Buying PAGE 20 »� What They’re Selling PAGE 22 »� What They Own PAGE 24 »� Stock Spotlight PAGE 26 »

Editors’ Letter“Why wouldn’t you look at whatother great investors have found?”Why, indeed. PAGE 28 »

I NVESTM E NT H IG H LIG HTS

Other companies in this issue:Acergy, Advanced Marketing Services,

Apple Computer, CBS, Clear Channel,

Comcast, First Data, Hewlett-Packard,

McDonald's, Microsoft, NewMarket, News

Corp., Ross Stores, Sears, Viacom, Wal-

Mart, Wendy's, Williams, Yum Brands

Not-So-Ugly DucklingsThere are plenty of prosaic companies in his portfolio, but Bob Robotti’s abilityto unearth great values over the past 20 years is anything but dull.

I N V E S T O R I N S I G H T

Ricky SandlerEminence Capital, LLC

Investment Focus: Seeks companiesearning high returns on capital which have“tripped” or are in secularly strong but currently out-of-favor industries.

The Leading Authority on Value Investing INSIGHT

www.valueinvestorinsight.com

INVESTMENT SNAPSHOTS PAGE

Applied Materials 6

Arbitron 9

Atwood Oceanics 14

Cisco Sytems 5

Drew Industries 15

Lexmark 10

Oracle 8

Pre-Paid Legal Services 17

Walter Industries 26

Zenith National 16

http://www.valueinvestorinsight.com

How has your investing philosophyevolved since you started your first firm,Fusion Partners, with Wayne Coopermanin 1994?

Ricky Sandler: The philosophy is stillvery much the same. We called it then andI call it now “quality value.” MorrisMark, for whom both Wayne and Iworked at Mark Asset Management, hada big influence because of his emphasis onresearch and on owning great businesses– great companies in secular growth busi-nesses with excellent industry structures.Morris was more willing to buy a greatbusiness with less regard for price, but webelieved you could pay too much for eventhe greatest business. We were also moreopen to the fact that there was a price atwhich a mediocre business could beattractive. So our focus was along thespectrum between “reasonable businessat a great price” and “great business at areasonable price”, with the rest beinguninvestable. That’s still what I do today.

One thing that has changed is my com-mitment to shorting. Wayne and I spent80% of our time on the long side and20% on the short side. Shorting was moreof an afterthought, we didn’t dig in asmuch on the companies there. But whenthe markets tanked in 1998 – and in sixmonths Fusion went from something likeup 15% to down 15% – I realized it wasvery uncomfortable to want to buy moreof what you own when you weren’t sureyou were still going to be in business. Weultimately ended up flat on the year, butwhen I started Eminence, I committed tobeing aggressive short sellers and spend-ing almost half our time on the short side.

You’ve said you think actively shortingmakes you a much better investor. Why?

RS: I saw in 1998 that without having acommitment to the short side, it’s difficult

to be offensive when you should be. Thehighest-return opportunities are availablewhen markets are in free fall, but if you’regetting shelled, you may not have theemotional conviction to be aggressivelyopportunistic and you may not even beable to do it, because of redemptions.Being able to be offensive when every-body else is defensive, in and of itself, canyield excess returns.

A second element is that as true, com-mitted short sellers, we have to beimmensely skeptical, and skepticism is aterrific quality in a value investor. A keyreason for our success is that we have avery high batting average on the longside. We’re better at avoiding mistakesbecause we’re very attuned to those situa-tions where value gets destroyed, orwhere it isn’t really there in the first place,say, because of phony accounting.

We employ gross leverage. Typical forus might be to be 120% long and 70%short. We could not be 120% long with-out also being 70% short – there’d be toomuch risk and volatility for our investorbase. People say shorting is a waste oftime and you never make money. I’d sayjust breaking even on my shorts allowsme to be 120% long and still not have alot of volatility. Shorting is and should bea profit center, but the benchmark peopleuse to compare against is often wrong.

The last element is that we believe thefundamental structure of a long/shortportfolio minimizes the systematic riskyou can’t control, say of a terrorist attackor a Russian debt crisis. If you employ thegross leverage we do, you’re then magni-fying your stock-specific risk – exactly therisk we feel we should be taking.

Do you tend to short specific companiesor baskets of stocks?

RS: We typically like to short individualstocks. Right now, though, we have a

I N V E S T O R I N S I G H T : Ricky Sandler

Investor Insight: Ricky Sandler

Value Investor Insight 2August 25, 2006 www.valueinvestorinsight.com

Ricky Sandler

Not Far From the Tree

Ricky Sandler couldn't have asked for amore compatible partner when he and fel-low Mark Asset Management analystWayne Cooperman started FusionPartners in 1994. They were both in theirmid-20s, shared a “quality value” orienta-tion and were sons of Goldman, Sachsalumni who had started their own thrivinginvestment firms: Harvey Sandler ofSandler Capital Management and LeonCooperman of Omega Advisors. “Weboth thought we were ready to run ourown portfolio,” says Sandler, “but therewas some comfort in having a partner todo that with.”

Within four years, Sandler andCooperman built $28 million in start-upcapital – $10 million from each of theirfamilies – into $350 million in assets. Buttheir investment styles were evolving in dif-ferent directions. “Wayne moved more toa deep-value emphasis, while I wasincreasingly focused on the quality of thebusiness,” says Sandler.

Since the partners went their separateways in 1999, Sandler's EminenceCapital and Cooperman's Cobalt Capitalhave both thrived. Says Sandler: “It goesto show you there are a lot of ways to skina cat in this business.”

Ricky Sandler of New York’s Eminence Capital describes why he’s finally gotten interested in technology stocks, why a seriouscommitment to shorting makes him a better investor, what he thinks the market is missing in Cisco, Applied Materials, Oracleand Arbitron, and why he thinks Lexmark is a great short.


bigger than average balance sheet on thelong side – closer to 160% long – becausewe’re finding all these big companies wewant to have 5% positions in. To supportthat, we’re now around 90% short,which is requiring us to use more indicesthan usual. The M&A environmentmakes us hesitant to significantly increasethe number of company-specific shortswe have. We were short Albertson’s. Wewere short Sports Authority. These arestructurally bad businesses that some-body came along and bought. We have tobe aware of that and not add too muchrisk to the portfolio by adding a lot ofnew individual short positions.

Back to the long side, what situations tendto result in your finding quality value?

RS: One is the good company in anindustry that’s out-of-favor, for whateverreason. Another is the good company thattrips – the disappointment that hasn’timpaired the long-term value of the busi-ness, but the market overreacts in pricingit down. The third would be the goodbusiness that isn’t necessarily in plainsight – it’s obscured, say, by other busi-ness lines or special situations. JoelGreenblatt talking in your last issue [VII,July 28, 2006] about American Express isa good example.

I’m probably more willing to pay upfor quality than other value investorsmight be. Some of my investor friendsoften tell me my ideas are “too high-qual-ity” for them. I would distinguish some-what here from paying up for growth –I’ll pay more for a high-quality, slow-growing business. I look for companiesthat will grow value, not necessarily rev-enue, at above-average rates.

The higher the quality of the business,the lower discount to our estimated valuewe need. We’re happy to buy a greatbusiness at 75 cents on the dollar.Something would need to be at 50-60cents on the dollar for us to buy amediocre business. On average, I’d sayour typical investment is 30-35% cheap-er than we think it ought to be and wethink it’s increasing value at 15-20% peryear on top of that.

Describe how you come up with ideas?

RS: Our best ideas tend to come fromwhat I call “old research, new events”.That’s typically the good company you’vestudied carefully and would love to ownat the right price, that gets marked downafter it trips or its industry goes out offavor. A great example was Yum Brands acouple years ago. Comp sales at one oftheir restaurant chains, KFC, were wayoff one quarter and the stock crashed35%. It instantly became an idea – I knewit was a good business and now it was onsale at a 35% discount.

We also learn a lot from otherinvestors. I go to idea dinners and regu-larly talk to a lot of people in the busi-ness. I’m not afraid of ideas owned byother people, but you obviously need todo your own work and make sure they fitwhat you do.

Many of our other ideas just comefrom having our eyes wide open. Youread publications like yours. You talk tocontacts you’ve developed in variousindustries. It’s often just about payingattention to what’s going on in the world.

On the short side, what attracts yourattention?

RS: We primarily look for material dis-connects between our view of economicearnings and the earnings that are report-ed and people are using to value thestock. It could be accounting related, sowe pay careful attention to things like ris-ing accounts receivable relative to totalsales, cash from operations that is notkeeping pace with net income anddecreasing returns on capital.

We also look for long-term structural

declines – kind of the opposite of what welook for on the long side. Wall Streettends not to fundamentally mark stocksdown until bad news actually shows up inthe numbers. We’ll ignore the supposedvalue today and focus on whether wethink the “E” in a P/E is going to be mate-rially less in three to five years.

Once you’ve identified a potential idea,what do you do next?

RS: We’ll put an analyst on it, who’salways paired on the idea with me or oneof the two other principals in the firm.We’re leveraging the senior person’s time,but also want more than one pair of eyeslooking at things.

We’ll prepare a basic two-page write-up after ripping through the 10-Qs, 10-Ksand proxy filings and listening to confer-ence calls. We want to get our armsaround the business both quantitativelyand qualitatively, so we summarize thingslike the company’s businesses, the com-petitive environment, recent financials,earnings quality, management, outstand-ing litigation and valuation.

What jumps off the page for you?

RS: I focus on return on capital and wantto see EBIT compared to invested capitalin the high-teens or better. We’ll look at itwith and without goodwill, to try to sep-arate out the impact of capital-allocationdecisions versus operating decisions.

We favor companies with some formof amortization, where we think cashflow is higher than reported earnings andthat may be one reason why the stock isundervalued. We want to understandhow net income plus depreciation andamortization is converted to cash flowfrom operations. Is anything getting lostin working capital or coming from othergains? We also focus on the relationshipbetween capital expenditures and depre-ciation, to better understand how capitalintensive the business is.

If we still think the idea is interesting,we’ll set up calls with the company to bet-ter understand how they operate andthink about things like capital allocation.



ON SHORT OPPORTUNITIES:

We’ll ignore the supposed value

today and focus on whether the

“E” in a P/E is going to be mate-

rially less in three to five years.


If that checks out, we’ll probably take a“R&D” position in the stock of 1-2%.

Why not finish your research before youstart buying?

RS: We’ve already done a lot of work, soit’s not like we’re winging it. Action addsa sense of urgency to the work – there areso many things to look at in this businessthat things can fall through the cracksunless you force yourself to focus. Havingcapital on the books does that.

We never stay at the R&D positionsize – it’s always then an up-or-outprocess. We spend another several weekson field research, visiting managementand speaking with as many people as pos-sible who can give us insight into thecompany and industry.

We tailor the field research to what weneed to know. In Yum Brands’ case, wespoke to a lot of franchisees to reallyunderstand the health of their system. It’snot about how sales are going this month,it’s trying to understand from the peoplein the trenches things like how good theproducts are, why they have the marketshare they do, what’s happening to themarket share and where the money ismade in the system.

When we find out the company’s a badbusiness partner, there are structuralindustry issues we didn’t know about ormaybe there’s an earnings miss we decideisn’t a short-term event – then we’ll sell.But if every step of the way you get moreexcited by what you uncover, those arethe companies that become 5%, 6%, 7%positions in the portfolio.

Most investors try to get some sort ofinformational advantage. What does ittake to be good at that?

RS: lt certainly takes a lot of effort to call40 Cisco distributors and get them to talkto you. It also takes a certain personality.People fundamentally like to talk aboutwhat they do, but they’ll only do that ifyou approach them the right way. Youalso have to listen very carefully. You mayask a distributor about price discountsand he’ll say, “That’s not much of an

issue, but trade-in values are going up.”That might be an interesting thing to pur-sue – you may have noticed inventoriesgoing up, but you didn’t really know why.

How long do you tend to hold positions?

RS: Our typical holding period is 18months to two years. We don’t activelytrade around positions, but we do man-age position sizes around our updatedanalysis of intermediate-term risk/reward.As that changes, we’ll add or subtract tolonger-term holdings.

Volatility can be a friend of the valueinvestor – it provides more situationswhere stocks significantly diverge fromtheir intrinsic value and can allow us toturn our capital faster. Say somethingmoves 50% in four months when wethought that might take two years. If it’snow 80-90% of what we think it’sworth, we’ll take money off the table andput it in something that maybe just got

hit and now has higher intermediate-term potential.

Do you have any strict rules for selling?

RS: No, every situation is different.

Let’s talk about some examples. Why didyou sell Wal-Mart in the third quarter oflast year?

RS: We sold half our stake because webegan to question our thesis. One of ourreasons for buying Wal-Mart was that wesaw material gross-margin opportunitythrough sourcing benefits and a reductionin import quotas. As the U.S. went backand forth on the quota issue, we startedto question whether that margin expan-

sion was going to happen. We sold the other half because we saw

a better opportunity. We’ve owned RossStores [ROST] off and on for years andwhen the stock got hit, we wanted to buyit without increasing our consumer dis-cretionary exposure, which we think isthe most stretched part of the economy.

Why sell Wendy’s earlier this year?

RS: We had bought in the low $40s, see-ing unrecognized value in the TimHortons chain and in real estate assets.With the stock at almost $60, that thesiswas played out. We sold because wethought the remaining upside – primarilyfrom fixing the core Wendy’s business –wasn’t high enough and would take toolong to be realized.

When Viacom broke into two pieces, alsoearlier this year, you bought more of theViacom piece and sold CBS. Why?

RS: We like businesses that grow invalue, and each of CBS’s businesses –broadcast TV, radio, local stations – isunder secular pressure. I think it’s a clas-sic cheap stock that is going to stay thatway. They can do things with the balancesheet to maybe take the shares from $25to the low $30s, but I think they’re hardpressed to fundamentally grow the valueof the business.

Viacom, on the other hand, has terrif-ic secular growth prospects. If the multi-ple doesn’t change, we think they’ll growtheir way into good returns. If the multi-ple does change to reflect that growth, theshares will really do well. We’ve been onthe wrong side of this trade so far, but Istand by the thesis.

We’re assuming selling your AppleComputer position in the third quarter of2004 is one you’d like back.

RS: We were early in seeing – and I stillbelieve – that the digital online business issaving the music industry. We thought theiPod might be huge and that the trend tomultimedia devices at home would playto Apple’s strengths. We bought shares,



ON SELLING WENDY’S:

We thought the remaining

upside – from fixing the core

business – wasn’t high enough

and would take too long.


pre-split, at $25, when the company hadsomething like $11 in cash.

The shares went pretty quickly from$25 to about $38 [$19, post-split], whichwe felt pretty good about. Then we start-ing thinking, “The hardware guy nevermakes money, it’s going to get commodi-tized, so we should stick with the ‘soft-ware’ guys like EMI.” We couldn’t havebeen more wrong on that one. [Appleshares closed recently at around $68.]

Do you focus on any particular industriesor sectors?

RS: It’s easier to describe what we don’tdo: oil and gas, commodities, utilities andbiotech. We fundamentally believe thatenergy and commodities have been value-destroying businesses over time. At thesame time, their value tends to be drivenby the price of a commodity that we haveno ability to predict. With utilities, theydon’t tend to be businesses that can createexcess value. They might be nice surro-gates for bonds, but not much more. Inbiotech, we just have no illusions that weknow how to analyze the business.Outside of these few areas, just aboutanything else is fair game.

You own a lot of technology companies.Has that always been a strength?

RS: Up until two years ago, I would havesaid we didn’t do much in technology –not by design, but because we rarelyfound companies that met our criteria.The great companies were valued ridicu-lously and the cheap ones were rarelygood businesses and could be wiped offthe face of the earth pretty quickly.

That world has changed 180 degrees.It’s really been in the last six to ninemonths that we’ve significantly increasedour holdings in technology. Some of thegreatest businesses in the world – stillgrowth companies in growth industries –are at significant discounts to small, lousycompanies and to the market. It goes backto where we tend to find quality value.You find it when whole industries or sec-tors are out of favor, and both large-capsand technology are out of favor.

A perfect lead-in to talking about somespecific stocks. Tell us about your interestin Cisco [CSCO]?

RS: The company essentially makesswitches and routers, which direct IP traf-fic within an internal network or betweennetworks. The fundamental driver fordemand of this type of equipment is thegrowth and complexity of data traffic. Ifyou think about what’s happening withthings like music, voiceover IP telephonyand the transmission and downloading ofvideo files, the growth tailwind behindthis industry is quite interesting.

This is a case where we probably did

more field work than usual, focusing veryclosely on Cisco’s competitive advan-tages. Why are they able to maintain 70%gross margins? Why do they have suchincredibly high market shares?

What we ultimately concluded wasthat Cisco’s service levels, combined withthe critical nature of this infrastructure,made competitors a non-factor. No one iswilling or able to work with customersthe way Cisco does in training them andmaking sure everything is working. Givenhow important the functions being sup-ported are, we kept hearing how it didn’tmake any sense to go with somebody elseto save 20-30%.



Cisco Systems(Nasdaq: CSCO)

Business: Global manufacturer and mar-keter of routers, switches and other digitalnetworking products that facilitate data,video and voice communications.

Share Information(@8/23/06)

Price 21.0552-Week Range 16.83 – 22.00Dividend Yield 0.0%Market Cap $128.50 billion

Financials (TTM):

Revenue $28.48 billionOperating Profit Margin 25.0%Net Profit Margin 19.6%

THE BOTTOM LINE

Cisco’s unassailable competitive strength in a business ideally positioned to benefit asthe volume and complexity of data traffic grows is not being adequately valued by themarket, says Ricky Sandler. At a more appropriate valuation, he believes the sharesare worth at least $25, with value compounding 20% annually on top of that.

I N V E S T M E N T S N A P S H O T

CSCO PRICE HISTORY

Sources: Company reports, other publicly available information

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152004 2005 2006

Valuation Metrics(Current Price vs. TTM):

CSCO S&P 500P/E 23.8 19.3P/CF 17.8 13.7

Largest Institutional Owners(@6/30/06):

Company % OwnedBarclays Global Inv 5.0%Capital Res & Mgmt 4.1%State Street Corp 3.0%Vanguard Group 2.5%Wellington Mgmt 2.0%

Short Interest (As of 7/10/06):

Shares Short/Float 0.6%


So it’s almost game-over in the enter-prise marketplace, where Cisco getsabout 80% of its business. In the carriermarketplace, they still have great share,but not quite as strong a position.Carriers have more sophisticated engi-neers in-house, so Cisco’s service isn’tquite as important, and price is moreimportant.

Are growth prospects slowing?

RS: We actually became convinced thatthis was an accelerating growth story,not just a growth story. In the last twoquarters you’re starting to see that hap-pen. First-quarter revenue growth was11%, up from 9%. In the second quar-ter, sales rose over 12%.

Do you consider management to be goodcapital allocators?

RS: One of the most impressive thingsabout Cisco has been the way they’veintegrated acquisitions. Most big compa-nies have done dumb acquisitions andthis is not one of them. They bring in aswat team and integrate the businessquickly into their own infrastructure andsales force. So we’re very comfortablewith their capital-allocation strategy,which is somewhat unusual for a tech-nology company.

The market didn’t like the ScientificAtlanta deal and I was a bit skepticalmyself. [Note: Cisco’s $6.9 billion acqui-sition of the set-top box maker closed inFebruary.] But if you start to thinkabout how telco and cable networks areconverging, how important video isbecoming to Cisco’s business and thetype of infrastructure Scientific Atlantahas, the deal begins to make more sensein helping Cisco provide solutions forvideo IP.

Having rebounded recently to just over$21 per share, how are you thinkingabout valuation?

RS: We started buying Cisco late lastyear when it was trading in the low- tomid-$17s. But even after the recent

move, the shares trade at only 15x bothcalendar 2007 earnings and after-taxcash flow, ex-cash. So we’re getting a7% free-cash-flow yield in a companywith a fortress balance sheet that isgrowing its top line at double-digits,without requiring capital. Assumingonly modest increases in operating mar-gins and continued share buybacks, wethink they can easily grow earnings at20% annually.

At a more appropriate multiple, wethink the shares should trade for at least$25 per share – with the value of thecompany growing by at least 20% annu-ally on top of that.

Applied Materials [AMAT] is anothertechnology leader you’re high on. Why?

RS: The company is the largest andmost dominant player in the semicon-ductor-equipment industry and operatesacross most of the industry’s verticals.Unlike Cisco – where I’d say the whole isgreater than the sum of the parts –Applied’s strength comes primarily fromits strength in the individual businessesthey’re in, which often have differentcompetitors and different industrydynamics. Their market shares rangefrom 10% to 80%, with an average inthe high-30s.



Applied Materials(Nasdaq: AMAT)

Business: Manufactures, markets and serv-ices a broad range of fabrication equipmentused by semiconductor manufacturers inNorth America, Asia and Europe.



Financials (TTM):


THE BOTTOM LINE

The prevailing wisdom that the semiconductor cycle is near its demand peak hasmade the company’s shares “incredibly cheap,” says Ricky Sandler. He believes thecycle has much further to run and that at the 16x multiple of next year’s estimatedearnings he believes the company deserves, the shares are worth closer to $25.


AMAT PRICE HISTORY


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AMAT S&P 500P/E 18.8 19.3P/CF 17.1 13.7


Company % OwnedCapital Res & Mgmt 12.1%Fidelity Mgmt & Res 4.0%Barclays Global Inv 2.8%State Street Corp 2.6%Vanguard Group 2.5%




There aren’t scale advantages?

RS: Scale does help them with the out-sourced foundries, like TaiwanSemiconductor, which are a growingpart of the business and want a one-stopshop. It’s less of an advantage with Intel,which has its own engineers and is morethan willing to buy etching equipmentfrom one company and lithographyequipment from another and put it alltogether.

Scale also helps them in the backend,in investing in development of next-gen-eration technology. It’s not the core ofour thesis, but management here reallygets how the technology is evolving andhow to create value. They’re alwaysdoing interesting micro things at anoperating level to diversify and expandtheir business.

What is the core of your thesis?

RS: There has been a massive underin-vestment in capacity in the semiconduc-tor industry since the bottom of the lastcycle in 2003. This has been an atypicalrecovery, as the foundries and othermanufacturers have been extraordinarilycautious in adding capacity, even as theyoperate near 100% capacity and even aswe continue to have great growth driversfor semiconductors. This industry hasgrown at double-digit rates for the last30 years and that will continue, as moreand higher-value chips make their wayinto new digital cameras, iPods, cellphones and computers.

We went back over time and com-pared overall semiconductor-industryrevenue with industry capital spending.The relationship has been relatively sta-ble, but two big things affect it overtime. One is that as wafer sizes get big-ger, capital spending per dollar of rev-enue actually drops, as customers getmore chip for their money. Offsettingthat, though, is that as the circuits oneach chip get smaller and more complex,the capital spending versus revenueincreases.

The first effect, from bigger wafersizes, is more of a one-time event with a

12-to-15 year cycle. The second effect,from increasing complexity, is more con-sistent and steady over time. The resultis that the curve plotting capital spend-ing against revenue slopes upward to theright, with one-time step reductionsevery 12 to 15 years.

The industry went through a wafer-size increase from 2001 to 2003 and wewon’t see another one until maybe 2014.So the key driver going forward, puttingupward pressure on cap-spendingrequirements, will be ongoing increasesin chip complexity. The combination ofthat dynamic and the fact that compa-nies have been so cautious about spend-ing makes us believe that we’re below

mid-cycle in semiconductor capitalspending. That is not the prevailing wis-dom, however, which says we’re muchmore near the peak of the cycle.

If the market thinks the cycle is peaking,how cheap has that made AMAT shares,now at $15.90?

RS: The shares trade at only 11xOctober 2006 free cash flow, ex-cash.That’s incredibly cheap – at below mid-cycle earnings – for a dominant compa-ny in a growth industry.

If the company grows just at the rate ofthe industry – 10-11% per year – I see noreason why this shouldn’t trade at a mid-to high-teens multiple of mid-cycle earn-ings. At 16x times next year’s earnings –which we think will to be closer to mid-cycle – this is a $25 stock, with double-digit annual growth in value beyond that.

The company also thinks the sharesare cheap. They have $3.40 per share innet cash and have been aggressively buy-ing back shares. They’ve been buying

back 6-8% of the company per year andthat’s likely to go up.

Moving to another technology titan,what do you think the market is missingon Oracle [ORCL]?

RS: Oracle, of course, is one of thelargest software companies in the world,with a roughly 35% market share indatabase software, 17% of the applica-tion-sever market and a growing appli-cation-software business. About 65% oftheir total revenue is maintenance andservices, which is extremely stable andsustainable.

One of the appeals here is that this isa maturing, big company that reallyunderstands how to use its balancesheet. In 2004, they started buying best-of-breed application-software compa-nies, which, financially, has been a verygood use of capital. Oracle runs at 40%operating margins and can go into aPeopleSoft, say, and take them from15% margins to 40% or higher by inte-grating them well.

In each of the big acquisitions –PeopleSoft, Retek and Siebel Systems –the prevailing concern has been thatOracle would abandon the acquiredproducts in order to shove their ownproducts down customers’ throats.Customers wouldn’t like it and, as aresult, license sales in applications woulddrop. If you look at Wall Street’s sell-sidemodels for the company, combinedapplications revenue over the next cou-ple of years is estimated at maybe 20%below what the separate companies gen-erated in 2003.

What you find when you go out in thefield, though, is that customers havebeen surprised at how well Oracle hassupported, upgraded and maintainedthese newly acquired applications. Byintegrating what they’ve bought andmaking each of the individual piecesstronger, they’re starting to regain mar-ket share from competitors like SAP. Thebottom line is that we believe there’smeaningful upside to the market’s expec-tations on how Oracle is executing onthese acquisitions.



ON CHIP CYCLES:

We believe we’re below mid-

cycle in semiconductor capital

spending. That is not, however,

the prevailing wisdom.


Is the growth potential here as high as itis at Cisco or Applied Materials?

RS: It’s a bit less, in the high single-dig-its, but the inherent stability is higher.The core database business has very highretention rates, a large recurring mainte-nance revenue stream, very low capitalrequirements and it generates tremen-dous cash flow. We don’t believe themarket fully recognizes the sustainabilityof that business. If you look at the ana-lysts’ models, they don’t have interestincome building up or the share countcoming down – as if all the cash they’regenerating just disappears into thin air.

How does Larry Ellison’s stewardship fitinto your thesis?

RS: He’s obviously a visionary who hasbuilt one of the country’s outstandingcompanies. We’ve spent more time withthe co-Presidents, Chuck Phillips andSafra Catz, and think they’re very disci-plined operators who really get wherethe company is in its lifecycle. We thinkit’s a nice balance – a visionary at thetop, combined with people who reallyunderstand financial management.

At a recent $15.30, what upside do yousee for the shares?

RS: Our estimate for calendar 2007 freecash flow is $1.15 per share, higher thanthe $1 consensus estimate that we thinkmisjudges how well the company is exe-cuting. That’s a 13.5x multiple for acompany with a great franchise, greatmargins and growing at a stable rate inthe high single-digits. We also see this asworthy of a mid- to high-teens multiple,worth $21-22 per share, with growthbeyond that.

We’re guessing Arbitron’s [ARB] ties tothe radio business aren’t doing the stockany favors.

RS: Therein lies the opportunity.Arbitron supplies ratings to the radioindustry, which are then used to selladvertising. We’re going into a digitalworld where radio audiences are becom-ing more fragmented and, while thatmight concern radio broadcasters, it’sactually a big positive for Arbitron.

Arbitron’s ratings business is one ofthe all-time great businesses. Its data isthe certified currency advertisers use tobuy radio advertising. They’re a monop-oly supplier – in a business where itmakes sense to have only one supplier –to an industry that can’t survive withoutits product. In 2004, CBS balked atArtbitron’s contract terms and tried toplay hardball with them. Arbitron stocktook a hit, but a month later, CBS signedup. They really had no choice.

What’s particularly interesting nowabout Arbitron is that they have two sig-nificant projects – the rollout of the“portable people meter” and what theycall Project Apollo – that are penalizingearnings. You see sell-side analystreports saying nothing is going to hap-pen with the stock because the earningsare down, but the earnings are downbecause investments are going up forgood reason.

What’s a portable people meter?

RS: It’s a small pager you clip on thatpicks up an inaudible code that eachradio station sends out, automaticallytracking what you’re listening to. It



Oracle(Nasdaq: ORCL)

Business: Develops, markets and servicesdatabase, middleware and application software products for large enterprise customers worldwide.



Financials (TTM):


THE BOTTOM LINE

Ricky Sandler says the market isn’t fully recognizing the sustainability of the company’sdatabase business and how well it is executing against its recent application-softwareacquisitions. If Oracle delivers the growth in profits he expects, he believes the shareswill be worth 40-45% more than their current price of $15.32.


ORCL PRICE HISTORY


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52004 2005 2006


ORCL S&P 500P/E 24.3 19.3P/CF 19.4 13.7


Company % OwnedCapital Res and Mgmt 9.9%Barclays Global Inv 2.4%State Street Corp 2.1%Fidelity Mgmt & Res 2.0%Vanguard Group 1.9%




knows if you switch stations, if there’sradio on in the background at the storeyou’re in, or if you’re listening over theInternet. The meter data will be muchmore precise and accurate – and there-fore valuable – than information fromthe paper-and-pencil diaries that are cur-rently used.

Is the technology ready for primetime?

RS: The technology hasn’t yet gottenMRC [Media Ratings Council] accredi-tation, but it’s close. We don’t thinkthere’s a risk they won’t get accredited,it’s just a question of time.

A lot goes into the accreditationprocess. For example, the people metercan miss a signal if a horn is honking orthere’s some other noise interruption.There has to be a specific policy laid outfor how a situation like that is to be rec-ognized and the results recorded in thefinal data.

Arbitron is already one year into thegive-and-take of the accreditationprocess. The next-closest company isjust starting a friends-and-family sort oftest on whether their technology actual-ly works. This technology transition wasactually the one opportunity someonemight have had to attack Arbitron’s

franchise, and everyone’s at least threeyears behind.

What is the pricing difference for thepeople-meter ratings?

RS: It will be 30-50% higher. Part ofthat will be justified by Arbitron’s ownincreased costs in getting the informa-tion this way. But they’re also providingmuch more information that is of betterquality and more targeted. It scares somepeople in the industry and nobody lovesa big price increase, but I think it’s ulti-mately going to benefit the industryoverall – both in helping them sell and inprogramming, as they better understandpeople’s habits.

Most of the big radio players havesigned on, but Clear Channel is trying toplay hardball and see if they can find analternative. Because nothing else is closeto being ready, I think what will happenis the MRC accreditation will comethrough, Arbitron will start turning onmarkets with the people meter, and thelocal Clear Channel stations aren’t goingto be able to sell. They’ll ultimatelycome around.

What is Project Apollo?

RS: This is a joint venture with Nielsen –with Procter & Gamble also activelyinvolved – that will marry people-meterdata across different media with actualpurchase behavior. I call it the “holygrail” for advertisers and the potential isenormous. This is long-term optionality,though – you’re not paying at all for thisin the stock price.

The shares, at around $35.50, don’tlook particularly cheap.

RS: With the investment spendingincluded, Arbitron is expected to earn$1.75 per share this year, so people see20x earnings and think that’s expensivefor a company supplying a troubledindustry.

If you exclude the people-meter andApollo expenses, though, the stocktrades for only 9.5x 2006 EBIT and



Arbitron(NYSE: ARB)

Business: Media and marketing researchfirm focused on the measurement and composition of local and national radio audiences in the U.S. and Mexico.



Financials (TTM):

Revenue $320.2 millionOperating Profit Margin 26.0%Net Profit Margin 18.0%

THE BOTTOM LINE

Excluding the investment spending on projects that Ricky Sandler expects will pay offhandsomely, the company’s shares trade for only around 14x estimated 2006 netincome. That’s too cheap for the ongoing franchise, he says, let alone for the growthfrom new products he thinks can make the shares a “major, major homerun.”


ARB PRICE HISTORY


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ARB S&P 500P/E 19.3 19.3P/CF 16.0 13.7


Company % OwnedEminence Capital 11.4%Neuberger Berman 10.9%Schupf & Co 9.2%Capital Res & Mgmt 6.8%Pamet Capital Mgmt 6.2%




around 14x net income. That’s cheapjust for the ongoing radio franchise with5-6% annual top-line growth and amonopoly business. But we expect thepeople-meter rollout for radio to ulti-mately result in a roughly 40% lift torevenues and profits. On top of thatyou’ve got optionality from the peoplemeter doing other things – it can alsotrack TV usage and outdoor advertising,for example – and from the eventualrollout of Project Apollo.

We started buying this within the lastsix months and now own more than10% of the company. We think it couldbe a major, major homerun.

Tell us about one of your short ideas,Lexmark [LXK]?

RS: This is a case where we think themarket is giving the company the benefitof the doubt as they try to fix some oper-ating mistakes, primarily because peoplebelieve the printer business is a greatbusiness.

Hewlett-Packard and Lexmark usedto own the business – with Lexmark atthe low end – selling hardware at little orno margin and making a ton of moneyon ink and supplies. That’s all consider-ably changed, to the point that webelieve the printer business is no longera great business. Epson, Canon,Samsung, Xerox and other competitorshave expanded in the business and thestandard now is to lose 20 to 40 pointsof gross margin on hardware. It’s stilltheoretically a razor/razor blade model,except it costs you a lot more money togive the razors away.

As printers have become so cheap, thereplacement cycle has increased fairlyquickly. With a two-year replacementcycle, how valuable is the “blade” busi-ness in a hotly competitive market whenyou can lose market share almostovernight? That’s a particular problemfor Lexmark, which never had that greata brand and was primarily just the cheapalternative.

It’s early yet, but the growth in pri-vate-label replacement ink is also goingto be a negative for the whole printer

industry. If your business model isreliant on very high ink prices, heavierprice competition in that area won’t begood news.

Is Lexmark’s manufacturing of Dell-branded printers a positive or negativefor the company?

RS: I think the relationship has hurtLexmark because Dell beats them up onprice and then basically gives the print-ers away with their computers. By defi-nition, then, the person getting the print-er may not actually want it and maynever use it. So the add-on consumables

business Lexmark needs just doesn’tmaterialize.

Won’t positive secular growth trends inprinting, such as increased photo print-ing and use of color, benefit Lexmark?

RS: We think their product line is verypoorly positioned and that they haven’tinvested enough in R&D to change that.They’ve historically been heavily skewedto black-and-white, inkjet printers, whilethe world is going to color and to laser. Soeven if the overall printer business grows,we don’t see Lexmark taking muchadvantage.



Lexmark(NYSE: LXK)

Business: Manufacturer of inkjet, laser anddot-matrix printers – as well as associatedink and supplies – for both home and commercial use.



Financials (TTM):


THE BOTTOM LINE

The computer-printer business is no longer the great business it once was andLexmark’s product line and undistinguished brand name make it particularly vulnerableto competition, says Ricky Sandler. “We view this as a long-term short – their marketshare is going down and we don’t think that’s going to change,” he says.


LXK PRICE HISTORY


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LXK S&P 500P/E 19.1 19.3P/CF 10.5 13.7


Company % OwnedMaverick Capital 7.1%Franklin Resources 7.0%State Street Corp 5.1%Brandes Inv Partners 4.4%Barclays Global Inv 4.3%




The stock, close to $100 two years ago,now trades around $55. How muchworse can it get?

RS: The shares are both well off theirhigh and well off their low. When quar-terly earnings fell off a cliff late last year,the stock crashed down to the low $40s.Since then, they’ve actually beaten earn-ings estimates handily in the last threequarters. They’ve been pulling out oflines of business where they were losingeven more money than usual on printersales. Optically, earnings go up whenyou stop selling negative-margin hard-ware and you cut a lot of costs. But bylater this year, when you start toanniversary when they started to losehardware share, we think you’ll startseeing a negative impact on consumablessales from the lower installed base.

The stock trades about 14x this year’scash earnings and, we think, at 16x nextyear’s. So Lexmark trades at a premiumto all the great growth businesses wespoke about earlier and we think itsbusiness is disintegrating. We view this

as a long-term short – their market shareis going down and we don’t think that’sgoing to change. I would go so far as tosay I think this company could go awayin the next five years.

Are there any general short themesyou’re focused on now?

RS: One is our view on the relative val-uations of large-caps versus small-caps.Most of our shorts are in small-caps. Onthe index side, we’re short the Russell2000 – it trades at a 20% premium tolarge-caps, but it has much worseprospects and is much more levered tothe domestic economy.

The last five years have been reallygreat for small-caps and, like everythingelse, it tends to go on longer than it real-ly should. I think that’s been exacerbat-ed by the growth of hedge funds. Mosthedge-fund managers don’t look at aCisco because it’s too big and too well-followed and they don’t know what theiredge is going to be. They like to find –and their investors want them to find –

the obscure little things. My feeling onthat is that investors pay us to find valueand value is in the Ciscos of the worldright now.

What do you like most about investing?

RS: You mean besides the incrediblyattractive financial characteristics?

[Laughing] Yes, we’ll take that as agiven.

RS: I love learning about businesses andthe intellectual challenge of investing.I’m also intensely competitive about gen-erating great returns. I love that you geta scorecard at the end of the day and Ilove to win. Winning to me is lookingback after 30 years and saying, “Wow,look at that track record – these guys didit well and they did it right.”

That’s not to say I’m particularly fondof those days when you feel like an idiotand your numbers make you look like anidiot. But as a competitive person, Iwouldn’t have it any other way. VII



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I N V E S T O R I N S I G H T : Robert Robotti

Your portfolio is a hodgepodge of less-than-glamorous stocks. Is there a commontheme to your investing?

Bob Robotti: The first security I everbought, which worked out very well, wasa defaulted New York City HousingAuthority bond at 36 cents on the dollar.When I set up my own firm in the early1980s, we focused at the beginning mostlyon pink-sheet, trade-by-appointment typestocks. So I’ve always been a bit attractedto distressed or messier situations.

Our general focus is on companies thatattract little attention from Wall Streetand/or are beaten up and out of favor. Weusually invest in small- and micro-caps,where I still think there are more opportu-nities to find things that are truly ineffi-ciently priced. I want to believe going inthat things we buy can double in pricewithin the next two or three years.

You’re a big proponent of special-situa-tions investing. What kinds of situationsattract your attention?

BR: We’ve been successful with a varietyof special situations, such as spin-offs,bankruptcies and rights offerings. Withrights offerings, for example, these areusually done by companies under somestress and we’re looking to see insidersstep up as standby purchasers in the offer-ing. You’re basically looking for an insid-er trade, where people in a position toknow the business better than the marketmight be telling you something.

One of our biggest wins ever was withStolt Offshore, a deep-sea, oil-and-gasdrilling contractor which is now calledAcergy. It trades on the Oslo exchange andon Nasdaq [ACGY]. In May of 2004, thecompany did a rights offering as one of thefinal events in a long restructuring. TheOslo exchange has a rule that if you do a

private placement of shares, you have tooffer the same terms to public sharehold-ers, which turned out to be an offeringprice of $2.20 per share.

The $2.20 share price valued the com-pany at around $400 million. That was fora company with $1.5 billion in revenue, nonet debt and fixed assets with replacementvalues far in excess of $400 million. Newmanagement had restructured the businessand industry consolidation was improvingcontract terms and pricing. We bought1.25 million shares in the offering, increas-ing our position by four to five times.

We didn’t need energy prices to go up todo well on this, but when they did,demand for Stolt’s services took off.Almost every piece of equipment they haveis contracted out for the next two or threeyears. Today, the stock trades around $18.

Have you taken money off the table?

BR: We’ve sold very little. They now have$300 million in cash, no debt, around $2billion in revenue and will earn $1.40 pershare this year. The number of deep-waterprovinces where you can find and pro-duce oil and gas is going to double overthe next five years, as provinces open upin Australia, Malaysia, China and else-where. That’s where people are lookingnow and that’s going to be very good forAcergy’s business. I think this can ulti-mately be a 25x-multiple stock when peo-ple recognize the strength of their busi-ness and how well positioned they are.

Do you pay attention to share buybacks?

BR: We often look at cases in which acompany with significant insider owner-ship is aggressively buying back shares, butthe insiders don’t participate in the buy-back. Again, that indicates that someonewho may know more about the business

Investor Insight: Robert Robotti

Robert Robotti

By the Books

Bob Robotti was “bitten by the investmentbug” while serving on the audit team por-ing over the books of Tweedy, Browne Co.in the late 1970s. “It became quite clear tome that investing was far more interestingthan the ‘ticking and footing’ of the audit-ing process,” he says.

Robotti, however, has not turned his backon his accounting roots. “Bob is withoutpeer in drawing insight about a companyand its business from its financials,” saysMario Cibelli (VII, June 30, 2006), whoonce worked for Robotti and now manageshis own investment partnership. In fact,Robotti lets the numbers do much of thetalking when analyzing a company. “I findthat subjective judgments about manage-ment and the industry are tough to makeuntil you’ve actually owned the shares for awhile,” he says, “We focus first on an objec-tive look at the reported numbers.”

The post-Enron shift toward tougheraudits and board scrutiny of financialreporting has created new opportunity forsleuths like Robotti. One of his most fertileareas for ideas today? “Companies delin-quent in filing their financial statements,”he says. “It’s a real growth area.”


Robert Robotti of New York’s Robotti & Co. explains which special situations most attract him, the parts of the energy sectorhe thinks have the brightest prospects, why tougher audits create opportunity and where he sees unrecognized value in AtwoodOceanics, Drew Industries, Zenith National and Pre-Paid Legal Services.


wants to own more at a particular price. An example of that – which took a

long time to play out – is the old EthylCorp., which does chemical additives forpetroleum products and is now calledNewMarket [NEU]. In the late 1990s, thecontrolling Gottwald family bought back25% of the outstanding stock at $46.25 –adjusted for a 1-for-5 reverse split – andwe began buying about a year later whenit traded down to $35.

Unfortunately, the business deterioratedand the stock a few years ago got down toabout $4, which was 1x trailing 12-monthcash flow. We liked that the company wasgenerating cash and paying down debt,and we thought the industry dynamicswere finally changing for the better, so webought a lot more. The business turnedaround beautifully and it’s still a big posi-tion for us. [NewMarket shares closedrecently around $61.]

We see that like any good value investor,you’re not afraid of doubling down whensomething goes against you.

BR: You have to be willing to do thatwhen you invest in the types of companieswe invest in, where things often get worsewell before they get better.

I don’t want to leave you with theimpression, however, that it alwaysworks. In the late 1990s I had about a12% portfolio position in SuperiorNational, a big player in California work-ers’ compensation insurance. I increasedmy position in a rights offering and it gotto as much as 20% of my portfolio.When the workers’ comp business inCalifornia fell apart, the company turnedout to be too leveraged and the shareswent from $22 to zero.

Ouch.

BR: The lesson wasn’t to not be aggres-sive, but to not be overweighted in any-thing that’s so leveraged that it really hasthe risk of going to zero. Acergy is nowabout 13% of my portfolio, but it has nodebt and $300 million in cash. The earn-ings might slow down, but there’s noissue with the viability of the company.

Are there relatively new special situationsyou’re seeing more of?

BR: One newer area is companies that aredelinquent in filing financial statements.Up until 2002-2003, corporate audits werereally commodity items and there was lit-tle value added. The value added, such asit was, was in distorting the economic real-ity to fit accounting rules and regulations.The world today is very different and audi-tors have come to rule the world. With

long, drawn-out audits and conflicts overreporting, you see more and more compa-nies fall behind in filing, getting de-listedor even choosing to de-register their sharesto avoid filing requirements. Those thingsusually cause a dramatic repricing of theshares and may provide opportunity.

Can you give a current example?

BR: We own Advanced Marketing Services[MKTS.PK], which trades in the pinksheets. The company distributes books,mainly to major wholesale-club retailerslike Sam’s Club, Costco and BJ’s. In 2004,they discovered that the head of marketingwas defrauding customers. They had tohire forensic accountants and lawyers totrack the extent of the fraud and determinethe restitution to customers, so theybecame delinquent in their filings with theSEC. As a result, they got kicked off theNew York Stock Exchange in April of lastyear and the stock went from $7 to about$3.50, which is when we got interested.

There was enough information avail-able that we thought the stock was tradingfor less than our $5-per-share estimate ofwhat the restated, tangible book valuewould be. The balance sheet was mainlyreceivables and inventory – the receivables

from blue-chip clients and the inventorywas mostly books returnable to the pub-lishers for full refund. The company wasand is losing money, but it has in the pastearned around $1 per share, which webelieve should be achievable again.

Unfortunately, rather than get in com-pliance and resume their listing, the com-pany now says they plan to de-registertheir shares. It will still trade in the pinksheets, but we’re concerned about theinformation we’re going to get going for-ward. The stock now trades around $3,and while the risk has increased, we stillthink there’s value here.

You’re a long-time investor in the energybusiness. Where do you stand on the ques-tion of whether things are “different thistime” with respect to prices?

BR: Our portfolio is currently about 30%in energy, so it’s the biggest industry expo-sure we have. Having invested in the busi-ness as long as I have, the one thing I knowabout energy prices is that whatever theconsensus is about future price movementswill be wrong. It always is.

The big increase in energy prices hasadded a lot more commodity risk to invest-ing in the sector today. It’s harder to betotally agnostic about the prevailing pricelevels. I do believe the energy market hasfundamentally changed and there will be anew long-term, market-clearing price forenergy that is higher than it has been. Howmuch higher, I have no idea. The excesssupply in the global industry actually start-ed to be used up by the mid-1990s.Because this is a long lead-time, capital-intensive business that has gone through20 years of underinvestment, it will takemany years for responses on the supplyand demand side to work their waythrough the system.

As that happens, what areas of the energybusiness do you consider most attractive?

BR: In general, I believe the service com-panies are more attractive than produc-ers in the current environment. Whetheroil is $40 per barrel or $70 per barrel, I’dargue it’s not going to have that much



ON OIL-SERVICE COMPANIES:

Whether oil is $40 or $70 per

barrel, I’d argue it’s not going

to have that much impact on

demand for services.


impact on demand for services. Many ofthe big oil companies have decliningreserves and will be desperate to addreserves. To do that, they’ve got to spendon finding and developing new produc-tion or getting more production out ofwhat they already have. Well-positionedservice companies will benefit from thattrend for a long time.

As I mentioned earlier with Acergy,service companies involved in deep-waterexploration should be particularly strong.Exploration success as the number ofprovinces expands will only breed moreactivity. At the same time, because of theexpense and lead times on the capacityside, there’s much less risk of oversupplythan with land-based drilling.

Tell us about another of your favorite oil-service holdings, Atwood Oceanics [ATW].

BR: Atwood is a contractor of large off-shore drilling rigs. Four of their rigs aresemi-submersibles, which can drill in3,000 to 5,000 feet of water, for whichthe leasing rate is now about $400,000per day. The other rigs they own, whichdrill in shallower water, go for closer to$200,000 per day. There’s huge operat-ing leverage at current rates: operatingcosts are $45,000 per day on the semi-submersibles and $30,000 per day on theshallower-water “jack-ups.”

From investing in energy for a longtime, you develop an appreciation forsmart managements that know how tooperate in a cyclical business. They don’tspend money on capacity when everyoneelse is and they add it on the cheap whenno one else wants to.

From 1982 to 1991, Atwood didn’tspend a penny on equipment becausethey thought the business was going to beoversupplied for years. Then in 1991they bought an interest in three rigs for$6 million. They spent $10 million torefurbish the equipment and then in1995 bought the remaining interest foranother $16 million. So for $32 million,they owned equipment that had beenbuilt in the early 1980s for $240 million.They’re very good capital allocators andunderstand how to build value.

Isn’t the concern here that many in theindustry won’t be so prudent and toomuch capacity will be added?

BR: Exactly. There are currently around200 deep-water rigs on the market – semi-submersibles and drill ships – and another35 are under construction. Most of thoserigs are not being built by the traditionalindustry players, but by speculators whoare betting on day rates staying high.

Is that too much new capacity? As Isaid, I’m convinced demand for deep-water drilling is going to explode. So muchso that I don’t think the market will be ableto meet the demand, even with the new

capacity. The world just needs the produc-tion from these deep-water provinces.

How does this view play out in your earn-ings estimates for Atwood?

BR: Their full fleet is contracted out fornext year and almost all contracted the fol-lowing year. Based on contracted rates, thecompany should earn $5 per share next fis-cal year and more like $9 in fiscal 2008.Given that some contracted rates are wellbelow current rates and that they have anew rig coming on in 2008, we think sus-tainable earnings – at current market con-ditions – are more like $11-12 per share.



Atwood Oceanics(NYSE: ATW)

Business: Houston-based contractor oflarge-scale offshore rigs used in the drillingof exploratory and developmental oil andgas wells around the world.

Share Information(@ 8/23/06):


Financials (TTM):


THE BOTTOM LINE

Oil companies desperate to add energy reserves will fuel a long-lived explosion indemand for the deep-water drilling equipment the company provides, says Bob Robotti.Based on contracted day rates and the addition of new capacity, he believes the com-pany’s sustainable earnings are $11-12 per share, less than 4x today’s share price.


ATW PRICE HISTORY


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ATW S&P 500P/E 19.1 19.3P/CF 13.8 13.7


Company % OwnedColumbia Wanger Asset Mgmt 7.2%Trafelet & Co. 4.6%Barclays Global Inv 4.1%Mackenzie Financial 4.0%Mellon Financial 3.6%

Short Interest (@ 7/10/06):



Given our view on supply and demand, webelieve that’s sustainable for some time.

With the stock recently around $41, themarket seems to disagree.

BR: Yes, given that the shares trade at lessthan 4x what we think the company isgoing to earn in three years, the sustain-ability of earnings is clearly where ourview differs from the market.

The company will have no debt by themiddle of next year, so their net earningswill be mostly cash earnings. So withinthree years, then, not only will they beearning at a very high level, but they willhave accumulated $20 or so per share ofcash. If that happens, it doesn’t take verysophisticated math to arrive at a shareprice significantly above where it is today.

What if oil prices go down?

BR: Exploration to find a deep-water fieldcosts $5-7 per barrel. Producing it thencosts another $3-5 per barrel. So whetheroil is at $75 or $40 won’t make that muchdifference on demand.

What attracted you to your next pick,Drew Industries [DW]?

BR: This is a relatively straightforwardstory. Drew sells component parts – likewindows, doors, chassis and axles – tomanufacturers of recreational vehicles andmanufactured homes. They do businesswith almost all manufacturers and proba-bly have 50% market share in both busi-nesses. The revenue mix is two-thirds RVs,one-third manufactured housing.

There are two main things that attract-ed us here. First, we’re convinced theyhave an excellent model for growth.They’ve been very good at identifyingproducts that will have broad appeal andthen making small acquisitions to fill outtheir product line and leverage their rela-tionships and sales infrastructure.

We’re also big believers in the turn-around potential of the manufactured-housing industry – where Drew operates atmaybe 50% of capacity and where theyhave historically earned higher margins.

Why do you think the manufactured hous-ing business is set to improve?

BR: The industry has been beaten up forsome time. In the late 1990s, the industrywas selling 370,000 new homes per year,driven by very aggressive financing offers.Many of those loans blew up, dumping alot of inventory on the market. At the sametime, falling interest rates made stick-builthomes a more affordable option for manypeople. As a result, sales of new manufac-tured homes fell to 130,000 per year andhave stayed around that level.

We now think higher interest rates willrefocus many low-end buyers’ attention on

the relative affordability of manufacturedhousing. Lending to the industry is nowmuch stronger and default rates are waydown. In fact, terms have gotten so rigidthat legitimate potential buyers – who gen-erally have lower FICO scores – can’t getloans. We expect that all to adjust as timegoes on. Clayton Homes is the biggestplayer in the industry and you can imagineone reason Berkshire Hathaway bought itwas for the opportunity to lend money tohelp finance the industry’s rebuilding.

Getting back to even 200,000 newmanufactured homes sold per year, whichis fully achievable, would result intremendous upside for Drew. We think



Drew Industries(NYSE: DW)

Business: Supplier of windows, doors,chassis and other components used in themanufacture of recreational vehicles andmanufactured homes in the U.S.


Price 24.9552-Week Range 20.95 – 38.90Dividend Yield 0.0%Market Cap $537.2 million

Financials (TTM):


THE BOTTOM LINEEarnings should increase at double-digit annual rates as the company capitalizes onadd-on acquisitions and an expected turn in its business supplying the manufactured-housing industry, says Bob Robotti. He expects significant multiple expansion – of atleast 50% from today’s 12x forward earnings – to accompany that growth.


DW PRICE HISTORY


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DW S&P 500P/E 14.0 19.3P/CF 9.9 13.7


Company % OwnedFidelity Mgmt & Res 8.6%Royce & Assoc 8.1%Munder Capital 5.6%Columbia Wanger Asset Mgmt 4.9%Mellon Financial 3.9%




that business can double for them in thenext few years.

With the stock currently trading just under$25, how are the shares valued?

BR: The stock currently trades at around11-12x our estimate of next year’s earn-ings. As they continue to add new productsand the manufactured-housing businessturns, we think earnings will increase atdouble-digit annual rates. With that kindof growth and the high-teens multiple webelieve the business will then deserve with-in three years, you’ve got a lot of upsidefrom today’s price.

After your Superior National experience,we’re surprised you still own a workers’comp company, Zenith National [ZNT].

BR: The California workers’ comp market– where Zenith does about two-thirds ofits business – is very large, very volatileand, as I learned firsthand, has historicallydestroyed a lot of capital.

It’s important to give some history hereabout the market. In the early 1990s, theeconomy in California turned down andpeople were losing their jobs. When thathappens, you see a big increase in workers’comp claims, because the benefits are gen-erally much better than those provided byunemployment insurance. This was allfacilitated by a significant number of less-than-ethical doctors and lawyers, who sawthis as a great way to make a buck.

That led to regulatory reforms in 1993-1994 that were meant to address theincrease in the number of claims and theresulting increase in the price of workers’comp insurance. They changed things likeincreasing how much of one’s stress had tobe related to their job to qualify for aclaim. They also cracked down on doctorand lawyer mills generating bogus claims.

Wall Street then came into the pictureand started to pour capital into workers’comp insurers in California. This tooended badly, because the companies wereoverly leveraged and thought they weretransferring a lot of risk to undisciplinedreinsurance companies who didn’t knowwhat they were doing. The result was that

the market got very undisciplined andstarted to crack in the late 1990s. FremontInsurance was seized by the state insurancedepartment. Superior went bust.

Where was Zenith during all this?

BR: Stanley Zax, who has run Zenith for30 years, is a very disciplined operatorwho has been through all the ups anddowns of the business. He kept Zenith ontrack and relatively well reserved, so thecompany came out of the turmoil of thelate 90s in a stronger position, as many ofthe dumb competitors went away.

Fast forward to today and you have a

much healthier industry. The major playersin the business are much better-run andnew regulations, such as requiring a med-ical-review process for claims, have beeninstituted. That all plays particularly toZenith’s hand, because their focus andexpertise is on smart underwriting andclaims management.

What does the current rate environmentlook like in California?

BR: Rates are coming down, but that’sbecause losses have come down. Giventhat, I don’t think Zenith’s margin of prof-itability comes down all that much over

Value Investor Insight 16August 25, 2006


Zenith National(NYSE: ZNT)

Business: Insurance holding company pri-marily focused on the underwriting ofworkers’ compensation insurance inCalifornia and Florida.

Share Information(@ 8/23/06)):


Financials (TTM):


THE BOTTOM LINE

Fears over the capital-destroying tendencies of the California workers’ compensationinsurance market are outdated, says Bob Robotti, and the healthier dynamics of theindustry bode well for disciplined competitors like Zenith. At a more appropriate 10xmultiple on normalized earnings, he believes that shares are worth $55-60 per share.


ZNT PRICE HISTORY


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ZNT S&P 500P/E 7.7 19.3P/CF 7.7 13.7


Company % OwnedGilder, Gagnon, Howe & Co 14.6%Fidelity Mgmt & Res 6.1%Barclays Global Inv 5.5%American Century 4.5%Vanguard Group 3.8%



the next couple of years. I also think they’llbe able to offset any rate decreases withboth increases in investment income andadjustments from excess reserves they’veput on the books in recent years.

Is there a growth story here?

BR: If there’s a negative, it’s that growthprospects – at least the way Stanley Zaxruns the company – are limited. He sticksto what he knows and executes well, but heshows little aspiration for growing his pol-icy count. Over time, then, the business willgrow as payrolls in their markets grow.

What upside do you see for the shares,recently trading just about $37?

BR: Last year Zenith earned $4.25 pershare, including a loss of about $1.30 pershare from a reinsurance business they’vesince exited. So the stock is trading at only6.8x the current earnings run rate of $5.50or so per share.

The stock is so cheap because every-body still assumes workers’ comp inCalifornia is a horrible business. We thinkif the market recognized the improveddynamics of the industry and gave Zenithfull credit for running a disciplined, con-servative business, a 10x multiple on nor-mal earnings of $5.50 to $6 per sharewould be more reasonable.

We’re curious, is Berkshire Hathaway get-ting more involved in the market?

BR: They actually bought a companyrecently, Applied Underwriters, which is aplayer in the workers’ comp business.These are pretty smart capital allocators,so we obviously see that as a positive com-ment on the business. It hasn’t happenedso it probably never will, but we’ve actual-ly thought Berkshire would be a logicalacquirer of Zenith one day.

There no dearth of controversy around yourlast idea, Pre-Paid Legal Services [PPD].

BR: Our interest is primarily based on ourconviction that they have a great product.For a monthly payment of around $25,

you get access to certain legal services forfree and to others at deeply discountedrates. We think that’s an interesting prod-uct offer for $300 a year, with applicabili-ty to even more people in the U.S. than forthe tax-prep services of H&R Block. Themodel is actually similar to H&R Block –providing a level of service most peopleneed on a more cost-effective basis.

Describe how the service works.

BR: You’re assigned a local law firm asyour point of contact, which improves cus-tomer service. The first time I tried to useit was when I bought my co-op. The prob-

lem was they wouldn’t get involved until Ialready had the co-op picked out, but inNew York you have to have your attorneyinvolved earlier in the search process to getaccess to certain information. So it didn’twork there. Where it did work for us: webought a $700 TV from Best Buy and itbroke a month or two later and theywouldn’t take it back. For no additionalcost, the Pre-Paid lawyer wrote a letter forus and we received a refund shortly after.

A friend of mine, who also owns thestock, bought his house in WestchesterCounty and used a Pre-Paid lawyer for hisclosing, paying less than half what everyother lawyer wanted. He’s even used one



Pre-Paid Legal Services(NYSE: PPD)

Business: Provider of legal services toroughly 1.5 million U.S. families who pur-chase plan memberships carrying monthlyfees of approximately $25.


Price 36.7752-Week Range 32.15 – 48.40Dividend Yield 3.3%Market Cap $533.7 million

Financials (TTM):


THE BOTTOM LINE

More-traditional marketing of the company’s proven and unique legal-services plan to abroader audience, combined with a heightened focus on customer retention, canunleash tremendous untapped revenue and earnings potential, says Bob Robotti.Success on both fronts, he says, would result in a “multiple” of today’s share price.


PPD PRICE HISTORY


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PPD S&P 500P/E 12.5 19.3P/CF 10.0 13.7


Company % OwnedThomas W. Smith 20.8%Steadfast Capital Mgmt 5.6%Goldman Sachs 5.0%Wellington Mgmt Co 4.3%Barclays Global Inv 3.9%




of their lawyers for routine securitieswork, at one-fifth the cost I pay for thesame work at my regular law firm.

Who is the target audience?

BR: The company says it’s not the top10% or bottom 10%, but the 80% inbetween. The reality is they reach mostlymiddle- to lower-income people, which Ithink is more a result of how they sell thanof who might benefit from the product.

A dreaded multi-tiered marketing system?

BR: Yes, they use a system just likeAmway’s, which is one reason Wall Streethates the company. We agree that how it’ssold is a limitation, but not based on anyelitist view of what’s appropriate.

The first problem is that by selling topeople you know, who sell to people theyknow, they don’t reach large parts of thepopulation – namely higher income levels.The current system also isn’t adequatelyeducating people on how to use the prod-uct and what a great value it is. The morepeople use and take advantage of the serv-ices, the longer they remain customers.

We think there’s great untapped poten-tial in promoting to a broader populationbase through advertising and more tradi-tional marketing. They also shouldenhance customer-service efforts to con-nect more often with paying customers.

The growth upside from doing both ofthese is tremendous – they win from dra-matically increasing the customer baseand from higher retention of the cus-tomers they already have.

The founder, Harland Stonecipher, stillruns the business. What makes you thinkthings will change?

BR: Management has been open to sug-gestions of certain long-time shareholders.Tom Smith, the managing partner ofPrescott Investors, has been on Pre-Paid’sboard since 2004. I’m sure he’s introduce-ing ideas that will continue to impact howthey look at the business. We see it alreadyin how they’ve started new programs to tryto increase usage, in how they’re looking

more carefully at the lifetime value of acustomer. They have more than enoughresources to invest in better marketing, andwe think they will.

We’re also optimistic about the identi-ty-theft product they launched in 2003 ina joint venture with Kroll. It’s a relativelyunique service that doesn’t just monitorfor problems with identity theft, but alsohas a restitution part if something goeswrong. Kroll is a part of Marsh &McLennan and the entire company isquite sophisticated in how they sell theirproducts. I believe this relationship canopen new doors to Pre-Paid.

Is the competitive environment agreeable?

BR: The other main players – the HyattLegal Plans division of MetLife and a for-mer Montgomery Ward business that’snow owned by General Electric – operatemostly in the corporate market, offeringplans as employee benefits. Pre-Paid is byfar the market leader with consumers.

The short interest, nearly 55%, is about ashigh as it gets. Why do so many investorsloathe the stock?

BR: There have been lawsuits against thecompany alleging various damages, usual-ly amounting to no more than a few hun-dred dollars each. One case, in Mississippi,resulted in a punitive-damage award of$9.9 million, which is now on appeal.Many business people would not consideran early negative verdict from aMississippi jury as great cause for concern,and we agree. The Connecticut AttorneyGeneral also announced he was lookinginto the company’s sales practices, butnothing’s come of that since it wasannounced with great fanfare a year ago.

There were accounting concerns, pri-marily over the company amortizing overthree years commissions on new customersales. Now those commissions areexpensed immediately. Today, cash earn-ings slightly exceed reported EPS.

With all this, we come back to the factthat we believe in the product – that it’s aproven, cost-effective service for con-sumers that has been around for 30 years.The “noise” has calmed down quite a bit,but sometimes a high short interest takeson a life of its own. As long as you’re com-fortable with your work, you just can’tworry about that.

The stock has been stuck near its currentlevel, around $37, since the beginning of2005. Where do you think it can go?

BR: The shares currently trade for around11x trailing earnings, if you adjust for thefact that the identity-theft earnings aretemporarily lower because the start-upselling expenses are being expensed imme-diately. There’s no capital spending, so theearnings translate to free cash flow.Protecting the downside is that they haveno debt and they’re using free cash flow tobuy back stock. The company has gonefrom over 24 million shares outstanding toless than 15 million today, which has hada significant effect on EPS growth.

I can’t give you a specific target numberfor the stock price. But if they can reallyget at the untapped potential I think thisproduct has, the share price will be a mul-tiple of what it is today.

You’ve been in the investment business forover 25 years. How would you say thebusiness has changed?

BR: You know, the particulars mightchange from time to time, but peopledrive the environment and human natureis pretty constant. A year ago,NewMarket shares were at $15 andnobody wanted them and today it’s at$61 and everybody wants to own it.Fundamentally, it was positioned a yearago to earn what it’s earning today.Things like that are as likely to happentoday as they were 25 years ago. VII



ON CHANGING TIMES:

The particulars might change

from time to time, but people

drive the environment and

human nature is pretty constant.


T he eclectic nature of valueinvestors is on full display in ana-lyzing the portfolios of the best of

the breed. Homebuilders like D.R. Hortonand Centex share space in portfolios withmedia companies such as Time Warner andNews Corp. Energy firms Transocean andWilliams stand alongside Microsoft andOracle. At the same time Greyhound-busparent Laidlaw International attractsattention, so do biotech firm Nuvelo andcontroversial videogame maker Take-TwoInteractive.

We’re coming to believe that the tradi-tional distinctions between “value” and“growth” investors are increasingly artifi-cial and irrelevant. As Charlie Mungeronce said, “All intelligent investing is valueinvesting,” meaning all smart investors aretrying to buy a stake in a company for aslittle as possible relative to its intrinsicvalue. But there’s great leeway in how oneascribes value to any given stake, from afocus on hard current assets to moreweight given to higher future profits. Thebest investors are comfortable with assign-ing value from along that continuum, as isclearly evidenced by the breadth of busi-nesses in their portfolios.

This is not to say there aren’t core prin-ciples that set apart the SuperInvestors wetrack. They tend to buy what’s out of favorrather than what’s popular. They investheavily in their best ideas rather than hidebehind the “safety” of closet indexing.They focus on generating high absolute

returns rather than on relative returns oroutperforming a benchmark. They typical-ly invest with a multi-year time horizonrather than focusing on the month or quar-ter ahead. They focus on the differencebetween a company’s current share priceand their estimate of its true worth, ratherthan trying to guess where the herd isgoing to go next.

Another trait we believe mostSuperInvestors share: an ability to learnfrom experience. Knowledge is cumulative,and savvy investors realize that there’s nocapacity limit on what one can learn andapply toward becoming a better investor.Our hope with SuperInvestor Insight isthat it can be an additional and regularcontributor to your own store of investingknowledge – with the help of the best“teachers” in the business. SII

I N T H I S I S S U EWhat They’re BuyingIndustry turmoil, as in healthcaretoday, typically creates valueopportunities that attract smartinvestors’ attention. Page 20

Table: Heart and HomeTable: Biggest New Bets

What They're SellingConsumer and financial stocks,light on buy lists in the secondquarter, are well representedamong popular sells. Page 22

Table: Consumer Isn’t KingTable: Up (or Down) and Out

What They OwnMedia and technology may be outof favor on Wall Street, but youwouldn’t know it from the portfo-lios of star investors. Page 24

Table: Core HoldingsTable: Below the Radar

Stock SpotlightUnfocused businesses tend toattract the attention of investorsexpecting change – witness thecase of Walter Industries. Page 26

INSIGHTSuperInvestor

From the Editors of Value Investor Insight

U P F R O N T

SuperInvestor Insight tracks the activityof an elite group of value-orientedhedge-fund managers (plus BerkshireHathaway), based on their holdings asfiled in Forms 13F with the SEC. Whilecertain activity of specific investors willbe highlighted, the focus is on drawingcollective insight from this group of 25-30 of the world’s best investors, whichcurrently includes William Ackman,David Einhorn, Joel Greenblatt, Carl Icahn, Seth Klarman, EdwardLampert, Warren Lichtenstein,Stephen Mandel, Larry Robbins,Jeffrey Ubben and many more.

The SuperInvestors

Distinction With aDifference

August 25, 2006

John HeinsCo-Editor-in-Chief

Whitney TilsonCo-Editor-in-Chief

SuperInvestor Insight 19

SuperInvestor Insight 20August 25, 2006

Healthy ExpectationsDynamic change, such as that currently roiling the healthcare industry, tends to create the types of value opportunities that attract smart investors.

It’s not surprising that the giant U.S.healthcare industry produced several ofthe most prevalent buying opportunitiesfor SuperInvestors in this year’s secondquarter. Shifting legal and regulatorywinds buffeting the industry, combinedwith hotly-competitive and high-growthmarkets, create the type of turmoil thatattracts against-the-grain investors.

Market skepticism about mergers-and-acquisitions activity appears to haveplayed a role in two healthcare buys.Stent-maker Boston Scientific completedits $27.5 billion purchase of Guidant dur-ing the quarter, but the stock remainsplagued by concerns that Boston

Scientific overpaid for damaged goods.Guidant’s sales of implantable defibrilla-tor devices have fallen due to concernsover the product’s safety and BostonScientific announced earlier this year thatit faced some 550 individual and class-action lawsuits related to problems withGuidant’s heart devices. BSX shares, at arecent $16.78, remain barely above theirsecond-quarter low.

While less controversial, ThermoElectron’s announcement during thequarter that it was merging with fellowlab-equipment supplier Fisher Scientificraised integration concerns about the$10.6 billion deal. Only recently upbeat

earnings news from Thermo havereturned the shares to their merger-announcement level of around $39.25.

Sentiment appears particularly dividedon one of the quarter’s biggest bets, thenew $280 million position reported byLarry Robbins’ Glenview Capital inOmnicare, which provides pharmaceuti-cal services to nursing homes. Omnicareshares are off more than 30% from theirMarch high as concerns over its Medicaidbilling practices have resulted in a recentfraud charge by the Michigan attorneygeneral. While Glenview was buying,however, three other SuperInvestorsclosed out their Omnicare positions dur-

Sources: Forms 13F filed with the Securities and Exchange Commission for holdings as of June 30, 2006.

Company Ticker Industry Price@8/23/06

Q2 2006 # of New or Inc. Positions

% Change In TotalShares HeldLow High

Microsoft MSFT Computer Software/Services 25.67 21.46 27.94 6 170.1%

Walter Industries WLT Diversified Industry/Construction 51.70 44.60 71.45 5 220.8%

NTL NTLI Cable TV 26.46 22.40 31.00 4 43.2%

Williams Companies WMB Oil & Gas 24.61 20.01 23.59 4 3626.4%

Dell DELL Computers 21.64 23.53 30.25 4 49.1%

UnitedHealth UNH Health Insurance 49.64 41.44 56.60 4 903.4%

Comcast CMCSA Cable TV 34.86 26.18 33.55 3 109.6%

D.R. Horton DHI Residential Construction 21.02 22.55 35.27 3 All new positions

Mirant MIR Power Generation 28.66 23.36 26.86 3 148.0%

Boston Scientific BSX Medical Devices 16.78 16.47 23.58 3 1200.1%

Caremark Rx CMX Specialized Health Services 56.40 42.40 50.66 3 101.6%

Centex CTX Residential Construction 48.59 44.13 64.62 3 165.5%

Smurfit-Stone Container SSCC Paper Products 11.17 10.21 15.15 3 145.1%

Thermo Electron TMO Medical Equipment 39.21 33.85 41.85 3 All new positions

Healthcare-related and home-builder shares attracted particular buying attention from superstarinvestors in the second quarter. Below are stocks in which at least three SuperInvestors establishednew positions or increased their existing share positions by more than 15% during the quarter.

W H A T T H E Y ’ R E B U Y I N G

What They’re Buying:Heart and Home




ing the quarter (see table, p. 22).Volatility in two previously booming

sectors, energy and housing, also resultedin significant buying activity. Fourinvestors increased their positions inWilliams, the natural-gas and power-gen-eration company which hit its 52-weeklow in March, as energy prices took ashort-lived dip. Mitch Julis of CanyonCapital argued in a recent Value InvestorInsight (March 31, 2006) that Williamsshares traded at a significant discount tothe sum of its parts, weighed down by acomplex business structure and the taintof past miscues in telecommunicationsand energy trading. Evidenced by theirpurchase of WMB shares, many of hispeers seem to agree.

The implosion of homebuilder sharesattracted multiple buyers to two compa-nies in the industry – D.R. Horton andCentex. As perceived-to-be-cyclical com-panies tend to do at the end of cycles,both trade at miniscule trailing P/E mul-tiples – Horton at 4.4x and Centex at5.2x – and are at least 40% off their 52-week highs.

While shares bought on non-U.S. mar-kets need not be disclosed in 13F filingswith the SEC, those in holdings of foreigncompanies with shares trading on U.S.exchanges are. The sole such companyappearing in this quarter’s buying activity

was Swiss-based food giant Nestlé, inwhich Ricky Sandler’s Eminence Capitaldisclosed a new $157 million holding atthe end of June. While we didn’t speakwith Sandler about Nestlé in this month’sinterview (see p. 1), the company was afeatured pick by Gardner Russo &Gardner’s Thomas Russo when we inter-viewed him in June (VII, June 30, 2006).Russo sees Nestlé as one of the world’s

best-positioned companies to benefitfrom increasing prosperity in developingcountries such as China and India.

Microsoft, in which six SuperInvestorssignificantly increased their holdings inthe second quarter, will certainly not be anew idea to readers of Value InvestorInsight. Co-Editor Whitney Tilson laidout his thesis for the shares in detail ayear ago (VII, July 29, 2005), focusing onthe software behemoth’s peerless brandfranchise, stellar economics and still-vitalgrowth prospects. The change in theshares over the past year: $0. He now hasplenty of elite company in expecting thecompany’s shares to prosper.

Will Dell shares replace Microsoft’s asthe computer industry’s latest dead-money champion? The shares, at a recent$21.64, trade below their second-quarterlow. The SuperInvestors apparently seepotential, though, as four of themincreased their holdings during the quar-ter. We wouldn’t bet against them.

Funds managed by Co-Editor Whitney Tilson

own Crosstex Energy, Dell and Microsoft.

SII


Q2 2006Investor Value @ 6/30

($mil)Low High

Omnicare OCR Specialized Health Services 43.30 41.00 58.02 Glenview $280.4

Crosstex Energy XTXI Oil & Gas 91.28 71.50 96.00 Chieftain $243.0

Comcast SPCL CMCSK Cable TV 34.73 25.99 33.40 Lone Pine $231.1

Microsoft MSFT Computer Software/Services 25.67 21.46 27.94 Greenlight $207.4

Boston Scientific BSX Medical Devices 16.78 16.47 23.58 Highfields $206.6

Nestlé NSRGY Food Consumer Products 84.30 71.85 78.45 Eminence $156.9

Valeant Pharmaceuticals VRX Pharmaceuticals 18.62 15.75 18.44 ValueAct $139.8

Walter Industries WLT Diversified Industry/Construction 51.70 44.60 71.45 JANA $119.1

Cigna CI Insurance 109.49 88.05 133.13 Icahn $104.4

Williams Companies WMB Oil & Gas 24.61 20.01 23.59 Omega $82.1

A willingness to make significant bets on their best ideas is a hallmark of superiorinvestors. Below are the ten largest brand-new positions taken by individualSuperInvestors in this year’s second quarter.

W H A T T H E Y ’ R E B U Y I N G

What They’re Buying:Biggest New Bets

ON DELL:

SuperInvestors are betting

against Dell shares becoming

the computer industry’s lat-

est dead-money champion.





Consumption PatternsConsumer and financial stocks, light on SuperInvestors’ buy lists in the second quarter,are quite well represented among the most popular sells.

The U.S. consumer’s voracious appetiteto spend has clearly been a significant con-tributor to the economy’s and the market’srelative health in recent years – fatteningcorporate profits along the way for thosepositioned to benefit. That the consumerspend-fest would end has been much antic-ipated, if not much observed.

From their portfolio activity in the sec-ond quarter, it would appear that manySuperInvestors are positioning themselvesmore for a slowdown in consumer spend-ing than the contrary. Money was takenoff the table in traditional consumer stal-warts such as retail and restaurants.Consumer-media positions were reduced,

as were those in financial firms tied closelyto the consumer.

Each individual story, of course, isdifferent. Four SuperInvestors eachdecreased their holdings in McDonald'sand Wendy’s following sharp turn-arounds in each company’s share pricesince bottoming in early 2003. Havinglost its way early in the decade,McDonald’s has turned itself aroundthrough wholesale menu and opera-tional changes and the shares haveresponded, nearly tripling from theirFebruary 2003 low to a recent $35.60.Wendy’s shares, recently around $63.50,have nearly doubled in the past two

years, partly through the efforts ofactivist investor Bill Ackman of PershingSquare Capital to force management'shand to spinoff its Tim Hortons dough-nut-shop empire and unlock hidden realestate value. That some investors in bothof these stocks have realized profits isn’tterribly surprising.

That four investors decreased theirholdings in Sears is somewhat surprising.The old-line retailer’s shares have per-formed remarkably well since investorEdward Lampert – whose fund is includedin the roster of SuperInvestors – took con-trol of the company. While Lampert’s rep-utation as a value creator remains



Q2 2006 # of Decreased or Closed Positions


News Corp. NWS Entertainment/Media 19.45 17.61 20.57 6 (-49.9%)

McDonald's MCD Restaurants 35.59 31.73 35.99 4 (-94.5%)

NRG Energy NRG Power Generation 50.16 42.44 52.61 4 (-34.5%)

Oracle ORCL Computer Software 15.32 13.07 15.21 4 (-48.3%)

Sears SHLD Retail Stores 142.40 130.38 167.95 4 (-80.3%)

Wendy's WEN Restaurants 63.46 56.25 63.65 4 (-69.6%)

Advanced Medical Optics EYE Medical Devices 48.15 43.94 50.87 3 (-31.2%)

American Express AXP Financial/Travel-Related Services 53.00 50.92 54.91 3 (-100.0%)

CBS CBS Media 28.34 24.05 27.24 3 (-59.7%)

Int'l Game Technology IGT Gaming Equipment 37.47 34.71 39.39 3 (-100.0%)

Kohl's KSS Retail Stores 60.89 51.51 59.73 3 (-44.3%)

Morgan Stanley MS Investment Banking 68.05 54.52 66.00 3 (-41.2%)

Omnicare OCR Specialized Health Services 43.30 41.00 58.02 3 (-100.0%)

Sprint Nextel S Telecommunications 16.42 19.33 26.89 3 (-51.4%)

Talisman Energy TLM Oil & Gas 18.10 14.93 20.33 3 (-95.8%)

TXU TXU Power Generation 65.24 44.10 59.93 3 (-54.3%)

Shares in retail, restaurant and entertainment companies came in for some selling bySuperInvestors in the second quarter. Below are companies for which threee or more superstarinvestors reduced their positons by 15% or more in the quarter.

W H A T T H E Y ’ R E S E L L I N G

What They’re Selling:Consumer Isn’t King




undimmed, the heavy Sears’ share saleswould indicate some smart investors feelthe easy money has already been made.

While strong share performance likelyexplains many of the quarter’s prevalentsales – in International Game Technology,Procter & Gamble and energy companiesTalisman, Suncor and Chevron, for exam-ple – other sales bear the whiff of capitula-tion. Warren Buffett’s Berkshire Hathawayappears to have closed its position in Gap,whose shares trade at the same level theydid in 1998. Freddie Mac shares, unloadedin volume by Chieftain Capital, haven’tmoved since 2001. Even worse is the per-formance of wireless provider SprintNextel, sold by three SuperInvestors,whose shares are off nearly 40% in thepast year.

That smart investors are bailing onSprint Nextel highlights the fact that eventhe best investors can arrive at diametrical-ly opposed positions on a given invest-ment. Legg Mason’s Bill Miller, for exam-ple, remains strongly bullish on Sprint’sprospects, as he recently explained toValue Investor Insight (June 30, 2006).

Similarly, Gotham Capital’s JoelGreenblatt sees great opportunity inAmerican Express shares – also explainedrecently in VII (July 28, 2006) – but threeSuperInvestors sold their positions entirelyin the latest quarter.

Messages are similarly mixed on News

Corp. While a total of six investorsdecreased their holdings in RupertMurdoch’s global media empire, fourretain holdings of greater than $50 millioneach. Less ambiguous was the reaction tobroadcast media’s CBS, which Viacomspun off earlier this year. As the sharesstarted to trade separately, three investorscollectively sold 60% of their CBS shares.

While SuperInvestors generally investfor the long-term, their opinions on a givencompany can change rapidly. Independentpower generator NRG Energy was a pop-ular pick in this year’s first quarter, held infive portfolios. The company was expectedto participate in consolidation in thepower-generation business, and, in fact,received a bid in May from competitorMirant Corp. The bid died, as, apparently,has enthusiasm for NRG’s shares.Interestingly, Mirant is currently on thepopular buy list (see table, p. 20). Itsresponse to the failed merger attempt hasbeen to restructure itself, selling off assetsand aggressively buying back shares.

It's inevitable that some sales appear tohave been premature. Shares of wholesalepower company TXU, which peaked inthe second quarter just under $60, nowtrade at around $65.25. That’s not at all acriticism – it’s just nice to see that sellingtoo early happens to even the bestinvestors, as well as to the rest of us.


own McDonald’s and Wendy’s.

SII


Q2 2006Investor Value @ 3/31

($mil)Low High

Freddie Mac FRE Mortgage Loans 61.80 56.50 63.99 Chieftain $403.3

Suncor Energy SU Oil & Gas 80.25 67.36 89.88 Lone Pine $348.4

Applied Biosystems ABI Medical Instruments 30.84 26.38 33.00 ValueAct $280.2

Teva Pharmaceutical TEVA Pharmaceuticals 34.30 29.83 43.90 Glenview $240.7

Sears SHLD Retail Stores 142.40 130.38 167.95 Pershing Square $206.4

Gap GPS Retail Stores 16.52 16.83 19.10 Berkshire Hathaway $186.8

Procter & Gamble PG Consumer Products 60.92 52.75 58.73 Blue Ridge $140.0

American Express AXP Financial/Travel-Related Services 53.00 50.92 54.91 JANA $128.0

PNC Financial PNC Banking 70.52 65.30 72.00 Third Point $114.4

Chevron CVX Oil & Gas 65.68 55.41 63.65 Highfields $103.2

Whether after great runs (Suncor Energy, Chevron, PNC), or not-so-great (Freddie Mac, Gap),big steps were taken out of these stocks in the second quarter. Below are the ten largest posi-tions that individual SuperInvestors eliminated during the quarter.

W H A T T H E Y ’ R E S E L L I N G

What They’re Selling:Up (or Down) and Out

ON CHANGING OPINIONS:

As Mirant’s bid for competi-

tor NRG Energy died, so,

apparently, did enthusiasm

for NRG’s shares.





High and Low ConceptWhile media and technology stocks have generally been out of favor on Wall Street, they're not out of favor in the portfolios of superstar investors.

It’s a safe bet that a similar list in early2000 of the most prominent large holdingsof superstar value investors would havelooked absolutely nothing like the listbelow. Cisco? Microsoft? Oracle? No way.Time Warner? News Corp.? Sprint?Highly unlikely.

Such are Wall Street’s changing moodsthat so many once-untouchable shareshave found their way into value-investorportfolios. As Eminence Capital’s RickySandler puts it in his interview in this issue(see p. 1): “Some of the greatest businessesin the world – still growth companies ingrowth industries – are at significant dis-counts to small, lousy companies and to

the market.” He describes in the interviewhis thesis for two such companies, Ciscoand Oracle, that were also held in volumeby other SuperInvestors at the end of thesecond quarter.

Not all of the popular technology-relat-ed holdings are large-cap icons. AgereSystems, spun off from Lucent in 2002 andcurrently sporting a $2.6 billion marketcap, has struggled to find its footing inhotly competitive markets for hard-disk-drive and communication-product semi-conductors, but is starting to deliverimproved financial results. Take-TwoInteractive Software, publisher of the con-troversial Grand Theft Auto series of

videogames, has been buffeted by hardtimes in the videogame business – due totransitioning game platforms – many ques-tions about its accounting and legal prob-lems over hidden sex scenes in some of itsgames. Take-Two shares, at a recent$12.67, are half their 52-week high. Evenbiotech company Nuvelo, with an activepipeline of cardiovascular and cancerdrugs in development, was owned by threeSuperInvestors at quarter’s end. With amarket cap of just over $1 billion, Nuveloreported $1 million in revenues in its latestquarter.

Media, both content and distribution, iswell represented on the widely-held lists.



52-Week Portfolios with$50+million

position


Comcast CMCSA Cable TV 34.86 25.35 35.31 5 14.6%

First Data FDC Payment Systems 41.28 38.60 48.88 5 15.1%

Microsoft MSFT Computer Software/Services 25.67 21.46 28.38 5 158.8%

American Tower AMT Communications Infrastructure 35.49 22.73 36.05 4 0.1%

News Corp. NWS Entertainment/Media 19.45 14.76 20.57 4 (-20.5%)

Time Warner TWX Entertainment/Media 16.54 15.70 19.00 4 0.0%

Transocean RIG Offshore Oil & Gas Drilling 67.04 52.34 90.16 4 20.8%

Tyco TYC Diversified Industry 26.19 24.65 31.28 4 13.3%

Cisco Systems CSCO Networking/Communcations 21.05 16.83 22.00 3 (-3.6%)

Dade Behring DADE Medical Testing 38.68 32.90 43.11 3 2.6%

Freescale Semiconductor FSL Semiconductors 28.80 20.87 33.04 3 2.2%

NTL NTLI Cable TV 26.46 19.99 31.00 3 42.2%

Oracle ORCL Computer Software 15.32 11.75 15.95 3 (-6.9%)

Sprint Nextel S Telecommunications 16.42 15.92 26.89 3 (-24.6%)

Williams Companies WMB Oil & Gas 24.61 19.35 25.72 3 135.3%

Media and technology stocks are well represented among those companies with multiplesuperstar owners. Below are stocks in which three or more SuperInvestors held positions ofmore than $50 million at the end of the second quarter.

W H A T T H E Y O W N

What They Own:Core Holdings




Five investors hold positions in excess of$50 million in Comcast, the bluest of bluechips in an industry beset by concerns overthe cost of competing with phone andsatellite companies. Also attracting atten-tion have been shares of NTL, the domi-nant market leader in the U.K. cable mar-ket, whose shares trade in the U.S.

Four portfolios each held big stakes inmedia titans News Corp. and TimeWarner. News Corp. is generally creditedas being the most international and nimblyrun media company, but its shares havedone little for the past five years. TimeWarner, blessed with remarkable mediabrands, is still reeling more than five yearsafter its disastrous merger with AOL – itsshares, after a steep plunge early in thedecade, have flat-lined for more than fouryears and trade today around $16.50.

It’s not all glitz and glamour, of course.Retailer Advance Auto Parts, automotivesupplier Lear and vehicle-salvage firmCopart were all owned by three or moreSuperInvestors at quarter’s end. WhileAdvance Auto and Lear are off 35% and50% respectively from their 52-week

highs, Copart’s business of auctioningcars from insurance companies for sal-vage value is growing nicely, and the com-pany had a debt-free balance sheet and

over $250 million in cash at the end of itsfiscal second quarter.

Offshore contract driller Transoceanwas the SuperInvestors most widely heldenergy bet, with large positions owned byfour investors. Bob Robotti of Robotti &Co. (see p. 12) – who doesn’t currentlyown Transocean – makes the case in hisinterview in this issue that offshoredrillers are particularly well positioned toprosper, as he expects deep-water drillingto significantly increase as oil companies

seek to replenish depleting reserves. The investment case for payments-

processor First Data, owned in five portfo-lios at quarter’s end, was made byGlenview Capital’s Larry Robbins in ValueInvestor Insight last fall (October 28,2005). Western Union, the company’smoney-transfer gem which Robbins feltthe market wasn’t fully valuing, is nowslated to be spun-off. One remaining risk:that Wal-Mart pulls its credit-card process-ing business from First Data if it ultimate-ly receives the bank charter it seeks.

Even the best investors have theirWaterloos, which appears to be the casefor three SuperInvestors in investmentmanager BKF Capital. Activist investorswere successful in gaining control of thecompany, but assets under managementhave since fallen off a cliff, leaving thecompany a shadow of its former self. Theshares, above $35 a year ago and still atnearly $20 earlier this year, now tradearound $4.


own Microsoft and Tyco.

SII


52-Week Market Value@8/23/06 (mm)Low High

BKF Capital BKF Investment Management 4.00 3.80 35.10 $32.9

Take-Two Interactive TTWO Videogames 12.67 9.06 25.07 $919.2

Nuvelo NUVO Biotechnology 19.41 7.53 19.89 $1,010.0

Lear LEA Automotive Parts 19.41 15.60 39.73 $1,310.0

Copart CPRT Vehicle Salvage 27.30 21.14 28.19 $2,470.0

Laidlaw LI Bus Transportation 25.81 21.09 29.40 $2,520.0

Agere Systems AGR Integrated Circuits 15.16 8.81 17.18 $2,570.0

Advance Auto Parts AAP Retail Automotive Stores 29.60 27.65 45.50 $3,110.0

Pioneer Natural Resources PXD Oil & Gas 41.78 36.43 56.35 $5,210.0

DaVita DVA Dialysis Services 56.79 43.99 60.70 $5,880.0

It isn’t only high-profile large-caps that attract the attention of great investors. Below are tencompanies with market capitalizations below $6 billion that were owned by at least threeSuperInvestors at the end of the second quarter.

W H A T T H E Y O W N

What They Own:Below the Radar

ON BKF CAPITAL:

Even the best investors have

their Waterloos. BKF shares,

above $35 a year ago, now

trade at around $4.





Out of FocusFew companies have as unlikely a mix of business units as Walter Industries – which explainsits attraction to so many SuperInvestors last quarter.

Investors’ appetite for conglomeratesrises and falls over time, but the empha-sis today is clearly that focus is a virtue.Focused businesses are considered morenimble and responsive to changing com-petitive environments. From an invest-ment perspective, the more uncluttered agiven business is – the thinking goes –the more likely it is to be accorded fullvalue by the market. That’s a big reasonbehind the steady stream of high-profilecompleted or contemplated corporaterestructurings of late: Viacom’s breakup,American Express’ spin-off of financial-advisory subsidiary Ameriprise, Tyco’sprospective breakup, First Data’s plansto spin-off Western Union … the listgoes on.

This backdrop may help explain whyconglomerate Walter Industries was oneof the most hotly pursued stocks bySuperInvestors last quarter. No fewerthan five investors increased their posi-tions by more than 15% in the quarter –and four of those were newly-establishedpositions.

Walter, based in Tampa, Florida, hasthree quite disparate lines of business,producing approximately $3.1 billion inannual revenue: Mueller Water Productsis a leading maker of piping, flow-controlsystems and end-of-line water transmis-sion products like fire hydrants. JimWalter Resources is a leading producer ofhigh-quality metallurgical coal, used bysteelmakers to make the coke that fuelsblast furnaces and by utilities in produc-ing steam. Jim Walter Homebuilding, thecompany’s original business, builds andfinances low-end single-family homesthroughout the southeastern U.S.

Walter’s motley crew of businesseslast year attracted the attention ofactivist-investor Pirate Capital, whichfiled a 13D with the SEC calling for thebreakup of the company to better realizeshareholder value. Walter has subse-

quently been responsive, agreeing to spinoff 25.1% of Mueller Water in an initialpublic offering in June and committingto dispose of the rest in a tax-free spin-off before the end of the year. Waltershares – at $15 only two years ago –traded as high at $71.45 earlier this yearbefore falling off sharply after theMueller IPO. They’ve recovered some-

what from their second-quarter low of$44.60 and recently traded at $51.70.

The ongoing investment thesis forWalter is relatively straightforward, saysGary Claar of SuperInvestor JANAPartners. “It’s just what we look for –value, plus a catalyst,” he says.“Business by business, each piece ofWalter deserves a more robust valuation

S T O C K S P O T L I G H T : W A L T E R I N D U S T R I E S

Walter Industries(NYSE: WLT)

Business: Conglomerate operating inthree discrete business segments: coaland natural gas, home building and water-system infrastructure.



Financials (TTM):


THE BOTTOM LINE

The company is in the middle of the process of rationalizing its disparate businesses,which should result in each being more highly valued by the market, says JANAPartners’ Gary Claar. JANA’s purchases of WLT shares during the second quarterwere at an up to 50% discount to the estimated value of the sum of its parts, he says.


WLT PRICE HISTORY


80

70

60

50

40

30

20

10

0

80

70

60

50

40

30

20

10

02004 2005 2006


WLT S&P 500P/E 46.1 19.3P/CF 62.6 13.7


Company % OwnedPirate Capital 8.5%JPMorgan Chase 7.9%Steel Partners 5.2%JANA Partners 4.7%Stephen A. Feinberg 4.6%

Short Interest (@7/10/06):





than it’s getting as part of a conglomer-ate, and they’re in the process of ration-alizing that structure.”

Mueller Water’s vertically integratedline of products is well positioned totake advantage of the heavy infrastruc-ture spending necessary to upgrade andreplace aging water systems throughoutthe country, says Claar. He believes thegrowth and sustainability of the businesswarrants at least a 10x multiple of earn-ings before interest, taxes, depreciationand amortization – 25% higher than the8x multiple it currently sports – which islikely only after Mueller shares are fullyspun out later this year.

The natural-resources business is alsoa much better business than it currentlygets credit for, says Claar, and mighteventually make an excellent acquisitiontarget for a large, diversified coal com-pany. High-quality metallurgic coal sellsfor a solid premium to lesser-quality coaland the location of Walter’s mines nearsteel mills in the southern U.S. gives the

company a cost advantage over manycompetitors. The business is tied to steel-industry cyclicality, but steel is in a rela-tively strong part of what many considerto be a long-lived cycle.

In addition, coal’s central role in

power generation, now less susceptibleto competition from higher-priced natu-ral gas, “makes coal companies a lot lesscyclical going forward than lookingback,” Claar says. He believes Walter’scoal business should trade for a premi-um 6x EBITDA multiple, up from less

than his estimate of 3.5x today.Even Walter’s homebuilding business

– which Claar calls “lousy” – has poten-tial upside. The company’s focus is pri-marily on homes priced between$50,000 to $150,000, which should bet-ter position it for a tough housing mar-ket. Just as low interest rates and easyfinancing allowed many low-incomebuyers to trade up from Walter’s typicaloffering during the boom, more difficulttimes should increase demand for itshomes. Claar values the business atroughly $5 per share and expects it ulti-mately to be sold to a competitor or in amanagement buyout.

All in, Claar says JANA bought intoWalter at a 30-50% discount to the esti-mated value of the sum of its parts. “Wetypically look for a very dynamic periodof a company’s public life when it under-goes a lot of change and gets revalued bythe market,” he says. “We think we’reright in the middle of that period nowwith Walter.” SII

S T O C K S P O T L I G H T : W A L T E R I N D U S T R I E S

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ON THE COAL BUSINESS:

Less susceptible to natural-

gas competition in power gen-

eration, coal should be a lot

less cyclical going forward.


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When we launched Value InvestorInsight eighteen months ago, we deliber-ately ignored the typical formula forinvestment newsletters. We made nopromises to regularly unearth the nextMicrosoft, or to double your money intwo weeks, or to let you in on ourSECRET!, PROPRIETARY! system formarket-beating returns.

What we set out to do was presentintelligent interviews and commentary oninvesting, drawing insight and wisdomfrom the best value investors in the busi-ness. The goal was – and is – to provideboth actionable investing ideas and ongo-ing learning on how to become a betterinvestor. Our aspiration is to help readersinvest more successfully tomorrow, nextyear … and ten years from now.

Like fingerprints, no two investingstrategies are exactly alike. We very muchbelieve there are central principles uponwhich sound investments are made, butany investor's given performance is a func-tion of hundreds of individual decisionsover time about what, how much andwhen to buy and sell. In this issue, RickySandler explains why he's never touchedenergy stocks and Bob Robotti describes

why energy makes up the largest share ofhis portfolio. Neither is “right” – and bothhave consistently produced remarkablereturns.

So if investing is the individualisticaffair we believe it is, why are we launch-ing a new quarterly newsletter – the firstissue of which is included herein – to trackthe latest portfolio activity of superstarvalue investors? The reason is that whilewinning investors clearly make their owndecisions, they also have an insatiableappetite for good ideas. That's the thesisbehind SuperInvestor Insight. Learningthat five of the best investors in the worldbought shares of Walter Industries lastquarter doesn't mean you should buy it,but our hope is that such knowledge mayspark a line of inquiry worth pursuing.What you do with it is up to you.

In fact, great investors freely admit torelying on their “grapevine” of peers forgood ideas. “We learn a lot from otherinvestors,” Ricky Sandler tells us in thisissue's interview. “I'm not afraid of ideasowned by other people, but you obvious-ly need to do your own work and makesure the ideas fit what you do.”Fairholme Fund's Bruce Berkowitz said

much the same thing to us earlier thisyear (VII, April 28, 2006): “Why would-n't you look at what other great investorshave found?”

We couldn't agree more. Each quarter,SuperInvestor Insight will analyze thecollective portfolio activity of 25 to 30 ofthe best value-oriented hedge-fund man-agers. The list will evolve over time, butwill always include the investors we mostrespect, such as Bill Ackman, DavidEinhorn, Joel Greenblatt, Seth Klarman,Stephen Mandel, Larry Robbins, JeffreyUbben and many more. The one non-hedge-fund manager included: WarrenBuffett’s Berkshire Hathaway.

A trial subscriber to VII called us earlyon to say he wouldn’t subscribe unless theformat evolved. “I basically want you totell me what to do,” he said. No, wewon’t do that. But we’ll keep doing every-thing we can to help you better figure itout for yourself. VII

Value Investor Insight 28August 25, 2006

E D I T O R S ’ L E T T E R

High-Level Networking


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Value Investor Insight™ is published monthly at www.valueinvestorinsight.com (the “Site”), by Value InvestorMedia, Inc. Chairman and Co-Editor-in-Chief, Whitney Tilson; President and Co-Editor-in-Chief, John Heins. Annual subscription price: $349.©2006 by Value Investor Media, Inc. All rights reserved.All Site content is protected by U.S. and international copyrightlaws and is the property of VIM and any third-party providersof such content. The U.S. Copyright Act imposes liability of upto $150,000 for each act of willful infringement of a copyright.

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Value Investor Insight and SuperInvestor Insight are published at www.valueinvestorinsight.com (the “Site”) by Value Investor Media,Inc. Use of this newsletter and its content is governed by the Site Terms of Use described in detail atwww.valueinvestorinsight.com/misc/termsofuse. For your convenience, a summary of certain key policies, disclosures and disclaimers isreproduced below. This summary is meant in no way to limit or otherwise circumscribe the full scope and effect of the complete Termsof Use.

No Investment AdviceThis newsletter is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solic-itation would be illegal. This newsletter is distributed for informational purposes only and should not be construed as investment adviceor a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a gen-eral or personal recommendation or take into account the particular investment objectives, financ ial situations, or needs of individualinvestors. The price and value of securities referred to in this newsletter will fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of all of the original capital invested in a security discussed in this newslet-ter may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and arenot suitable for all investors.

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