James’s Two Cents: Today’s Sleuth comes from my buddy and colleague Chris Mayer. Chris is the extremely successful editor of Capital & Crisis — a letter devoted to uncovering solid businesses at fair prices. Last year, Chris’s closed positions averaged a nice profit of 63%. And his current portfolio is up 38%.

Today, Chris explains why he is so successful. He also shows you what six companies are on his watch list right now. Make sure you read every word of this essay — two or three times over. It’s that good!

Chris, take it away…

Life is a big bowl of cherries. Provided you get most of them.”
– J.P. Donleavy, A Singular Man

Dear Sleuth Reader,

I’m not a conspiracy theorist. I don’t speculate about Halliburton’s plans to take over U.S. ports or how Arabs from Dubai are swimming across the Atlantic with dirty bombs strapped to their chests or how the Chinese are plotting to steal oil and gas from Texas.

But I’m not an Establishment thinker, either. They have rocks in their heads, or perhaps bats and biting lizards. But it is not brains, at least not the kind that think their own thoughts. They are hired hands. Wall Street’s job is to sell you paper. Whatever happens to the value of that paper after the sale is none of its concern. It is why I cannot work there, no matter how many fine cigars or bottles of expensive brandy or fancy invitations I receive. I’d rather labor in relative poverty knowing that what I write is what I think.

I am on a fringe of my own making. Capital & Crisis is an atavistic endeavor. Or to put is more simply, it is old school. My fellow editors chuckle at me. I read newspapers and magazines — in print, you see. I’m not talking about the electronic versions. I cut out articles and put them in folders around my office. They are not saved in some fancy desktop software. I read books. The kind with paper and binding. I have them lined around my office on bookshelves.

I don’t like instant messaging, blogging, podcasts and all the rest of that junk. I can be hard to reach. In my banking career, it took years before my boss finally convinced me to carry a cell phone. Finally, I relented. I just never turned it on. No BlackBerry or PDA for me. I go for frequent walks and I like rum with ice and lemon juice.

All of my favorite investors are 80 years old, or older, it seems. Or dead. Marty Whitman is over 80 years old. Benjamin Graham is dead. Many of my favorite economists are dead, like Murray Rothbard or Ludwig von Mises. Many of my favorite writers are dead. H.L. Mencken, A.J. Liebling, Hunter S. Thompson, P.G. Wodehouse, Raymond Chandler, Dashiell Hammett and Mark Twain. All dead. Henry David Thoreau. Dead. F. Scott Fitzgerald. Also dead.

I’ve recently discovered J.P. Donleavy. He has a unique style and amuses me on some level. Not surprisingly, he is 80 years old.

Old school. I look at financial statements, read 10-Ks and 10-Qs. I know my way around a 13F filing and an 8-K. These are lost arts. I look at facts. Good old-fashioned, stubborn facts. They are oppressive, I know. It means you can’t make stuff up.

Seth Klarman is one of my favorites. Just shy of 50 years old, he is a mere youth in my constellation. He learned his trade at the knee of the great Michael Price (of Mutual Series fame) who in turn learned the trade from that old vulture investor Max Heine.

Klarman is one of the greats. As the steward of Baupost, he has utterly destroyed the S&P 500 over the years, remarkably doing so while holding wads of cash and by taking few risks. I have his annual letter to shareholders in my hands, in hard copy, thanks to a contact I have who is an investor in his fund. Klarman is old school, like me.

Most of the letter is devoted to a discussion of risks. Klarman is the high priest of risk. He sermonizes on it lovingly, at length and often. There are some pearls, like this:

“Some animals can be domesticated, but not hurricanes and tsunamis. Dams and levees work, until they don’t. Meandering rivers simply don’t stay controlled, nor do financial markets. Federal Chairman Alan Greenspan has long been portrayed in the media as a savant who knows just the right interest rate to set and when exuberance is appropriate or excessive, a freak of nature who has tamed, for the benefit of mankind, the swings (particularly those unpleasant downswings) in the economy. But like a trained lion that turns on its handler, the economy may not stay tamed (or really have been tamed in the first place), for Greenspan or anyone else. Attempts to tame the economy, because they create a false picture of risk and thereby incentivize excessive risk-taking, are likely to backfire, resulting in greater economic swings than if no intervention had taken place.”

He goes through the laundry list of concerns — valuations are still high for most of the market, lots of capital sloshing around out there hungry for returns, high debt levels among consumers, the poor financial condition of the U.S. government, an inflation rate that is much higher than the stated rate and much more. 

Despite all of this, Klarman is buying — selectively. “The single greatest edge an investor can have is a long-term orientation,” he writes. With that in mind, let’s look and see what Klarman has been buying lately…

He has added significantly to his holdings in these companies:

News Corp. (NWS: NYSE)

News Corp. is Rupert Murdoch’s media empire — film, broadcasting, cable and satellite TV and print publishing. A lot of value types have been buying it here. Most feel that on a sum-of-the-parts valuation, News Corp.’s parts are worth more than the whole. It’s growing in the mid-teens, with a cash flow yield of about 8%.

QLT (QLTI: Nasdaq)

QLT is a biotech company. The stock has been on a long slide down over the last two years, but may have finally hit bottom. The stock is rising again. Statistically, it must be one of the cheapest stocks on the market. With lots of cash and very little debt, the company is in a strong financial position. It trades for an enterprise value to EBITDA multiple of less than 5.

USA Mobility (USMO: Nasdaq)

This is another statistically cheap stock. Good balance sheet and an EV/EBITDA ratio of less than 5. The company provides wireless messaging services. The merger of Arch Wireless and Metrocall in 2004 created USA Mobility. Wall Street hates it because who the hell still uses a pager in this age of cell phones? Well, lots of people still do. And they are loyal users. This thing throws off lots of cash, though its days as a growth stock are long gone. Cigar butt investing at its finest.

The following positions are entirely new, for the quarter ended Dec. 31, 2005.

Alliance One Intl. (AOI: NYSE)

Klarman added over 5.1 million shares of this little $4 stock to his portfolio over the last quarter. Alliance is a tobacco company. Despite lots of debt, the company appears to throw off stable and copious amounts of cash.

Horizon Lines (HRZ: NYSE)

Klarman added over 380,000 shares of this shipping and transportation company. The company pays a 3.4% dividend yield. Based out of North Carolina, this American company also runs several U.S. ports and could be one of the beneficiaries of the new hostility to foreign port operators.

Novelis (NVL: NYSE)

Klarman bought over 607,000 shares of Novelis, an aluminum producer and spinoff of Alcan. The share price has been beaten up, and Klarman obviously used that opportunity to pick up some shares. The company has some debt and trades for about 8 times EBITDA.

So there you have it, a peek over the shoulder of one of the best as he works. Not a bad group to put on your own watch list for further research. They are on mine.

Sincerely,

Chris Mayer
March 23, 2006

Chris Mayer

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