Value Investing World: June 2008

There are quite a few well-known value investors who have purchased shares in Target (TGT) recently. Current worries over the consumer slow down have taken the stock back down to levels below where most of them have bought. What kind of value might there be at these levels?

Target announced they’ve agreed to sell a 47% interest in their credit card portfolio to JP Morgan. Based on the sale price, Target’s remaining 53% is worth just north of $4 billion. They’ve also stated that they’ll complete about half of the $8.5 billion they have left on their buyback plan by the end of this year. Assuming they buy back at prices around $55 per share this year and the rest of the buyback (in ’09 and ’10) at around $70 per share, they should have about 700 million shares outstanding at the end of 2010. Taking out all revenue from the credit card portfolio and lowering margins a bit on the rest of the business, it seems reasonable that Target could make about $3 billion from their core business in 2010.

What could the shares be worth? Let’s do a quick back-of-the-envelope to see if it is worth looking into based on the following assumptions for 2010:

- $3 billion in earnings
- $4.5 billion value for their portion of the credit card portfolio
- 5% earnings growth for the 10 years after 2010
- 8-10% discount rates
- 12-15 terminal multiples

The above assumptions yield intrinsic values for Target at the end of 2010 between $72 and $92 per share (versus the current market price of about $48 per share). Target also owns about 85% of its real estate which helps provide some downside protection and maybe some potential upside not included in the above numbers. So, is Target worth looking into? That is a question you’ll have to decide for yourself!

*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision.

Brownout

What happens when you don't build more power plants? Get ready for spiking electricity rates, brownouts and even blackouts as demand soars

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If you think runaway oil prices are upsetting, just wait for what's in store for electricity. Similar forces are in play. Demand is rising fast; supply is not. The cost to get coal and natural gas out of the ground is going up, and to that expense must be added the cost of the carbon permits that Congress and the presidential candidates are contemplating. Environmentalists are getting power plants scotched. China is sucking up energy. Leave such dynamics in play long enough, and price spikes in electricity follow. But that's just the beginning. We may be facing brownouts (voltage reductions) and even rolling blackouts.
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By as early as next year our demand for electricity will exceed reliable supply in New England, Texas and the West and, by 2011, in New York and the mid-Atlantic region. A failure of a power plant, or a summer-afternoon surge in the load, could make for a blackout or brownout. "There really isn't any excess in the system," says Rick P. Sergel, chief executive at the North American Electric Reliability Corporation (NERC).
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Price shocks are already occurring. In May, long before peak summer demand, the wholesale price of juice jumped twofold in Texas, to $4 per kilowatt-hour, 25 times the average retail rate in the country. Prices exceeded the allowed rate of $2 for seven days and threatened the viability of power resellers who contracted to deliver cheap rates to consumers. New Yorkers may suffer a summer of price discontent if regulators are right about peak wholesale prices jumping by up to 90%.
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In the past few years, in dozens of utility regions such as Georgia, Louisiana and Ohio, price hikes have ranged from 20% to 80%. Overall, the cost of electricity, which declined (in real dollar terms) for the last two decades of the 20th century, has been relentlessly tracking up since 2001.
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While oil gets the attention, America uses just 15% more of it today than when the first modern energy crisis hit in October 1973. But electricity use is up 115% since then, thanks to all those plasma screens, iPhones, computers and data centers. And all economic forecasts see substantial growth in demand for electricity--think just of the coming electric cars--yet lots of problems in meeting it.
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Right now the nation has 760 gigawatts of power plants to meet current consumption, with another 154 in reserve capacity to maintain grid reliability. But in fact only 10 gigs is truly excess capacity. The other 144 is utterly essential to keep lights on when unexpected demand arises from heat waves, outages or maintenance downtime. That reserve will begin to shrink quickly. NERC estimates that over the next decade 135 gigawatts of new capacity will be needed to meet the growth in consumption. But right now plants producing a total of 57 gigawatts are planned.

Tuesday, June 17, 2008

The Confidence Man

Six years ago, hedge-fund manager David Einhorn made a speech at an annual investment conference about a stock he didn’t like—a mid-cap financial company called Allied Capital—and the world came crashing down on top of him. He was investigated by the Securities and Exchange Commission for conspiring with other investors to sink the stock. Allied stole his personal phone records in an attempt to prove the conspiracy. An article in The Wall Street Journal compared his treatment of Allied to “a mugging.” New York’s then–Attorney General, Eliot Spitzer, vowed to do his own investigation. And Einhorn’s wife, an editor at the financial weekly Barron’s, mysteriously lost her job.

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The repercussions of that one speech dragged on for years, an experience that would have embittered most people, or at least have made them back off. But Einhorn kept digging at the company, ultimately finding evidence of fraud that made his initial report seem tame. Then Einhorn took a very unusual step for a hedge-fund manager, most of whom would rather you didn’t know their names, much less how they run their businesses. He wrote a very candid and illuminating book about his firm, Greenlight Capital, and the complete Allied ordeal. The purpose, he says, was not to become famous or to settle scores; it was to tell people that he had been right all along. He wanted them to see the Allied story as having a “bigger meaning”—that the political, financial, and media Establishments can, and do, conspire to quash truth-telling.

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Book: Fooling Some of the People All of the Time: A Long Short Story By David Einhorn

Thursday, June 12, 2008

Fortune Article by Warren E. Buffett Regarding U.S. Trade Deficit - November 10, 2003

With all the foreign investment in the U.S. lately, capped off by InBev's offer for Anheuser-Busch, there is bound to be some kind of political upheaval. But, as Mr. Buffett discussed nearly 5 years ago, our country's trade policy has made this progression fairly predictable.

Why Foreigners Can’t Ditch Their Dollars

HOW OFTEN HAVE YOU SEEN A COMMENT LIKE THIS IN ARTICLES ABOUT the U.S. dollar? “Analysts say that what really worries them is that foreigners will start moving out of the dollar.”

Next time you see something like that, dismiss it. The fact is that foreigners—as a whole—cannot ditch their dollars. Indeed, because our trade deficit is constantly putting new dollars into the hands of foreigners, they have to just as constantly increase their U.S. investments.

It’s true, of course, that the rest of the world can choose which U.S. assets to hold. They can decide, for example, to sell U.S. bonds to buy U.S. stocks. Or they can make a move into real estate, as the Japanese did in the 1980s. Moreover, any of those moves, particularly if they are carried out by anxious sellers or buyers, can influence the price of the dollar.

But imagine that the Japanese both want to get out of their U.S. real estate and entirely away from dollar assets. They can’t accomplish that by selling their real estate to Americans, because they will get paid in dollars. And if they sell their real estate to non-Americans—say, the French, for euros—the property will remain in the hands of foreigners. With either kind of sale, the dollar assets held by the rest of the world will not (except for any concurrent shift in the price of the dollar) have changed.

The bottom line is that other nations simply can’t disinvest in the U.S. unless they, as a universe, buy more goods and services from us than we buy from them. That state of affairs would be called an American trade surplus, and we don’t have one.

You can dream up some radical plots for changing the situation. For example, the rest of the world could send the U.S. massive foreign aid that would serve to offset our trade deficit. But under any realistic view of things, our huge trade deficit guarantees that the rest of the world must not only hold the American assets it owns but consistently add to them. And that’s why, of course, our national net worth is gradually shifting away from our shores.

Monday, June 9, 2008

Bruce Berkowitz on WealthTrack

Bruce Berkowitz on WealthTrack: VIDEO

Thursday, June 5, 2008

Amazon.com's Jeff Bezos - Interviews

After reading a current interview with Jeff Bezos (HERE), I decided to search for old interviews and found one, from 2001, that I think is quite insightful. You can find that one HERE (excerpt below).

Here you were sitting in New York City in a very good job, a lucrative position with a future. You go home and you say to your wife you want to throw all that over and get in the car and go to Seattle. What possessed you to do that? What was her reaction? What is the role of risk taking?

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Jeff Bezos: I went to my boss and said to him, "You know, I'm going to go do this crazy thing and I'm going to start this company selling books online." This was something that I had already been talking to him about in a sort of more general context, but then he said, "Let's go on a walk." And, we went on a two hour walk in Central Park in New York City and the conclusion of that was this. He said, "You know, this actually sounds like a really good idea to me, but it sounds like it would be a better idea for somebody who didn't already have a good job." He convinced me to think about it for 48 hours before making a final decision. So, I went away and was trying to find the right framework in which to make that kind of big decision. I had already talked to my wife about this, and she was very supportive and said, "Look, you know you can count me in 100 percent, whatever you want to do." It's true she had married this fairly stable guy in a stable career path, and now he wanted to go do this crazy thing, but she was 100 percent supportive. So, it really was a decision that I had to make for myself, and the framework I found which made the decision incredibly easy was what I called -- which only a nerd would call -- a "regret minimization framework." So, I wanted to project myself forward to age 80 and say, "Okay, now I'm looking back on my life. I want to have minimized the number of regrets I have." I knew that when I was 80 I was not going to regret having tried this. I was not going to regret trying to participate in this thing called the Internet that I thought was going to be a really big deal. I knew that if I failed I wouldn't regret that, but I knew the one thing I might regret is not ever having tried. I knew that that would haunt me every day, and so, when I thought about it that way it was an incredibly easy decision. And, I think that's very good. If you can project yourself out to age 80 and sort of think, "What will I think at that time?" it gets you away from some of the daily pieces of confusion. You know, I left this Wall Street firm in the middle of the year. When you do that, you walk away from your annual bonus. That's the kind of thing that in the short-term can confuse you, but if you think about the long-term then you can really make good life decisions that you won't regret later.

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Most regrets, by the way, are acts of omission and not commission. If you do bad things, if you go murder somebody, that would be bad and that would be an act of commission that you would regret. But most everyday, ordinary non-murderers, when they're 80 years old, their big regrets are omissions.

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When you showed up in Seattle, you had left your job, you'd left any regrets you might have behind you. How do you get something like Amazon.com started? What did you have to do?

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Jeff Bezos: That blank sheet of paper stage is one of the hardest stages, and one of the reasons it's hard is because at that stage there's nobody counting on you but yourself. Today it's easy because we've got millions of customers counting on us, and thousands of investors counting on us, and thousands of employees all counting on each other. In that beginning stage it's really just you, and you can quit any time. Nobody is going to care, so you set about doing the simple things first.

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So, you want to start a company. Well, the first thing you do is you should write a business plan, and so I did that. I wrote about a 30-page business plan. I wrote a first draft. In fact, I wrote the first draft on the car trip from the East Coast to the West Coast. And, that is very helpful. You know the business plan won't survive its first encounters with reality. It will always be different. The reality will never be the plan, but the discipline of writing the plan forces you to think through some of the issues and to get sort of mentally comfortable in the space. Then you start to understand, if you push on this knob this will move over here and so on. So, that's the first step.

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We tried to get a lot of the little housekeeping details done even before we arrived in Seattle. I called a friend who lived in Seattle and asked if he could recommend an attorney. He recommended his divorce lawyer, but that's who we used. It was a general practitioner, a sort of small sole practitioner. He incorporated the company. He asked me on the cell phone what name would you like the company incorporated under. I said, "Cadabra, as in abra cadabra." And he said, "Cadaver?" I knew then that was not going to be a good name. We went ahead and incorporated under that name. We changed it about three months later.

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I stopped in San Francisco and interviewed vice presidents of engineering, because that was going to be an important long lead time item. We needed to build the technology that would run the store, and found the person who turned out to be the most important person ever in the history of Amazon.com on that trip. A guy named Shel Kaphan, who built all of our early systems. He had help from others, but he was the architect, he engineered them, and just did a fantastic job. So writing the business plan, the initial hiring, getting the company incorporated, all these are simple, almost pedestrian tasks, but that's how you start, one step at a time.

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Were investors knocking at your door?

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Jeff Bezos: Oh no.

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The first initial start-up capital for Amazon.com came primarily from my parents, and they invested a large fraction of their life savings in what became Amazon.com. And you know, that was a very bold and trusting thing for them to do because they didn't know. My dad's first question was, "What's the Internet?" Okay. So he wasn't making a bet on this company or this concept. He was making a bet on his son, as was my mother. So, I told them that I thought there was a 70 percent chance that they would lose their whole investment, which was a few hundred thousand dollars, and they did it anyway. And, you know, I thought I was giving myself triple the normal odds, because really, if you look at the odds of a start-up company succeeding at all, it's only about ten percent. Here I was, giving myself a 30 percent chance.

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Start up companies need early planetary alignment.

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There are so many things that can go wrong. When we launched that store in July of 1995, we were shocked at the customer response. Literally in the first 30 days we had orders from all 50 states and 45 different countries, and we were woefully unprepared from an operational point of view to handle that kind of volume. In fact, we quickly expanded. We talked to our landlord and we expanded into a 2000 square foot basement warehouse space that had 6 foot ceilings. One of our ten employees was 6'2, he went around like this the whole time. We were doing our day jobs which might have been computer programming – all the different things that 10 people will do in a tiny start up company. And then we would spend all afternoon into the wee hours of the morning packing up the orders and shipping them out. I would drive these things to UPS so we could get the last one, and we would wait till the last second. I'd get to UPS and I would sort of bang on the glass door that was closed. They would always take pity on me and sort of open up and let us ship things late. We had so many orders that we weren't ready for, that we had no real organization in our distribution center at all. In fact, we were packing on our hands and knees on a hard concrete floor. I remember, just to show you how stupid I can be -- my only defense is that it was late. We were packing these things, everybody in the company and I had this brainstorm as I said to the person next to me, "This packing is killing me! My back hurts, this is killing my knees on this hard cement floor" and this person said, "Yeah, I know what you mean." And I said, "You know what we need?" my brilliant insight, "We need knee pads!'" I was very serious, and this person looked at me like I was the stupidest person they'd ever seen. I'm working for this person? This is great. "What we need is packing tables."

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I looked this person and I thought that was the smartest idea I had ever heard. The next day we got packing tables and I think we doubled our productivity. That early stage, by the way of amazon.com, when we were so unprepared is probably one of the luckiest things that ever happened to us because it formed a culture of customer service in every department of the company. Every single person in the company because we had to work with our hands so close to the customers, making sure those orders went out really set up a culture that served us well, and that is our goal, to be earths most customer centric company.

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In a second round of fund-raising, about a year later or so, we raised a million dollars and I had to talk to about 60 different people. These were angel investors. Venture capitalists were totally uninterested. It wasn't like what people think of today.

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In 1998 and 1999 you could raise $60 million for an Internet idea without a business plan with a single phone call. It was a very different era, but back in 1995 it was very difficult to raise money. And, by the way, it wasn't more difficult than it had been for the previous 20 years to raise money, it just was sort of normally hard. It's supposed to be hard to raise a million dollars. So, with a lot of hard work we raised that million dollars from about 20 different angel investors who invested about $50,000 each, and that was the original money that really funded Amazon.com.

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Did you ever have any self-doubts, fear of failure?

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Jeff Bezos: In a strange way, no. Because remember...

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Once you are looking at the odds in a realistic way -- it's very important for entrepreneurs to be realistic -- and so if you believe on that first day while you're writing the business plan that there's a 70 percent chance that the whole thing will fail, then that kind of relieves the pressure of self-doubt. It's sort of like, I don't have any doubt about whether we're going to fail. That's the likely outcome. It just is, and to pretend that it's not will lead you to do strange and unnatural things. So, what you do with those early investment dollars -- if you have $300,000 and then you have a million dollars -- what you do with those early precious capital resources is you go about systematically trying to eliminate risk. So, you pick whatever you think the biggest problems are, and you try to eliminate them one at a time. That's how small companies get a little bit bigger, and then a little bit bigger, and a little bit bigger, until finally, at a certain stage, you reach a transition where the company has more control over its future destiny.

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When a company is very tiny it needs a tremendous amount of not only hard work but, as we talked about earlier, luck. As a company gets bigger it starts to become a little more stable. At a certain point in time the company has a much bigger influence over its future outcome and it needs a lot less luck and instead it needs the hard work. At that point there's a little bit more pressure, because if you fail you have nobody to blame but yourself.

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Monday, June 2, 2008

Jean-Marie Eveillard on WealthTrack

Jean-Marie Eveillard, Charles Ellis (The Investor's Anthology; Winning the Loser's Game), and Robert Litterman on WealthTrack: VIDEO 5/30/08
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Bruce Berkowitz will be on the show next week.