An Introduction to Value Investing Wednesday, November 5, 2008 Instructor: Whitney Tilson AGENDA AND SCHEDULE 6:00–6:15
1. Welcome and Overview of Value Investing • What is value investing? • Three steps to evaluating stocks • Trembling with greed • Focus investing • Variant perceptions • Gaining an edge • Traits of successful money managers • See columns: Thoughts on Value Investing, Three Steps to Evaluating Stocks, Trembling With Greed, Focus Investing, Go Against the Grain, Gaining an Investment Edge and Traits of Successful Money Managers
6:15–6:20
2. Valuing Companies • Discounted cash flow • Public company comps, acquisition comps, historical comps • Sum of the parts • See columns: A Valuation Rule of Thumb, Valuation Matters and Valuation STILL Matters
6:20–6:40
3. Common and Costly Mental Mistakes • Behavioral finance presentation • “Of Sound Mind” excerpts from Value Investor Insight • Eight columns on investor irrationality
6:40-7:00
Case Study #1: Berkshire Hathaway
7:00-7:15
Case Study #2: Fairfax Financial
7:15-7:30
Case Study #3: Target
7:30-8:00
Case Study #4: MBIA
Funds managed by Mr. Tilson are long BRK, FFH, TGT and short MBI. Page 1 of 95
Introduction What Is Value Investing? • Attempting to buy a stock (or other financial asset) for less than it’s worth • Contrast with greater-fool investing • False distinction between growth vs. value investing o “All intelligent investing is value investing.” – Charlie Munger • Intrinsic value • Margin of Safety • Does not necessarily mean buying lousy businesses at low valuation ratios Three Steps to Evaluating Stocks • Circle of competence o Do we understand this company and its industry deeply? o Can we make reasonable projections about the company’s future? o Keep it simple. Good investment ideas can usually be explained in 30 seconds • Company and industry evaluation o Is this a good business? Does it have sustainable competitive advantages? High returns on capital? Solid, steady growth? Healthy balance sheet? Strong free cash flow? o Often involves company visit, management and customer interviews. o Is this a good industry? Are the trends favorable? What are the competitive dynamics? o Look for an informational edge, often via proprietary sources or scuttlebutt research. •
Evaluation of management o Are they good operators? o Are they good capital allocators? o Are they trustworthy and shareholder friendly?
Trembling With Greed • Is the stock really, really cheap? • What is your variant perception? Focus Investing • When you get an easy pitch, swing hard o Owning two stocks eliminates 46% of non-market risk of just owning one stock o Four stocks eliminates 72% of the risk o Eight stocks eliminates 81% of the risk o 16 stocks eliminates 93% of the risk o 32 stocks eliminates 96% of the risk o 500 stocks eliminates 99% of the risk
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Buffett’s 20-punches analogy Sizing shorts and options
Variant Perceptions • “The hardest thing over the years has been having the courage to go against the dominant wisdom of the time, to have a view that is at variance with the present consensus and bet that view. The hard part is that an investor must measure himself not by his own perceptions of his performance but by the objective measure of the market. The market has its own reality. In an immediate, emotional sense, the market is always right. So if you take a variant point of view, you will always be bombarded for some period of time by the conventional wisdom as expressed by the market.” – Michael Steinhardt • “It’s much warmer inside the herd.” – Jean-Marie Eveillard • “If you just do what other people do, you will get the results other people get.” – Bill Miller Gaining an Edge • Three ways to beat the market: better stock picking, better market timing or more portfolio leverage. • Size • Time arbitrage o “Time arbitrage just means exploiting the fact that most investors – institutional, individual, mutual funds or hedge funds – tend to have very short-term time horizons, have rapid turnover or are trying to exploit very short-term anomalies in the market. So the market looks extremely efficient in the short run. In an environment with massive short-term data overload and with people concerned about minute-to-minute performance, the inefficiencies are likely to be looking out beyond, say, 12 months.” – Bill Miller • Concentration • Analytical • Experience • Emotional • Informational Traits of Successful Money Managers The right approach 1. Think about investing as the purchasing of companies, rather than the trading of stocks. 2. Ignore the market, other than to take advantage of its occasional mistakes. o “Basically, price fluctuations have only one significant meaning for the true investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market.” – Ben Graham
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3. Only buy a stock when it is on sale. o “To distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” – Ben Graham 4. Focus first on avoiding losses, and only then think about potential gains. o “We look for businesses that in general aren’t going to be susceptible to very much change. It means we miss a lot of very big winners but it also means we have very few big losers.... We’re perfectly willing to trade away a big payoff for a certain payoff.” – Buffett 5. Invest only when the odds are highly favorable -- and then invest heavily. 6. Do not focus on predicting macroeconomic factors. o “I spend about 15 minutes a year on economic analysis. The way you lose money in the stock market is to start off with an economic picture. I also spend 15 minutes a year on where the stock market is going.” – Peter Lynch 7. Be flexible! It makes little sense to limit investments to a particular industry or type of stock (large-cap growth, mid-cap value, etc.). o “We employ no rigid industry, sector, or position limits.” – Bill Miller 8. Shun consensus decision-making. o “My idea of a group decision is looking in a mirror.” – Buffett The right person Most successful investors have the following characteristics: 1. They are businesspeople, and understand how industries work and companies compete. o “I am a better investor because I am a businessman, and a better businessman because I am an investor.” – Buffett 2. They have a lot of intellectual horsepower. o However, “investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ” – Buffett 3. They are good with numbers -- though advanced math is irrelevant -- and are able to seize on the most important nuggets of information in a sea of data. 4. They are simultaneously confident and humble. 5. They are independent, and neither take comfort in standing with the crowd nor derive pride from standing alone. 6. They are patient. (“Long-term greedy,” as Buffett once said.) Templeton noted that, “if you find shares that are low in price, they don’t suddenly go up. Our average holding period is five years.” 7. They make decisions based on analysis, not emotion. 8. They love what they do. o “I’m the luckiest guy in the world in terms of what I do for a living” and “I wouldn’t trade my job for any job” and “I feel like tap dancing all the time.” – Buffett
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Thoughts on Valuation Discounted Cash Flow • Present value of a 10-year Treasury note • Same analysis for a stock or bond • Focus 90% of your attention here Public Company Comps • Make sure comps are valid • Make sure entire sector isn’t misvalued Acquisition Comps • What multiples are acquirers (other companies or LBO firms) paying for similar companies? • Strategic vs. financial buyers Historical Comps • What multiples has this company traded at in the past? • Has the business changed? • Careful to exclude bubble periods Sum of the Parts • Often useful to break business down into its parts and value each part separately Rules of Thumb • Pay no more than 10x trailing earnings (normalized) for a fair business and no more than 20x trailing earnings for even the greatest business • Paychex, Google, eBay
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Common and Costly Mental Mistakes By Whitney Tilson November 2006
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What is Behavioral Finance? Peter Bernstein in Against the Gods states that the evidence “reveals repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty.” Behavioral finance attempts to explain how and why emotions and cognitive errors influence investors and create stock market anomalies such as bubbles and crashes. But are human flaws consistent and predictable such that they can be: a) avoided and b) exploited for profit?
Why is Behavioral Finance Important? “Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ…Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” -- Warren Buffett Page 7 of 95
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Common Mental Mistakes 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) 15) 16) 17) 18) 19) 20) 21) 22) 23) 24) 25)
Overconfidence Projecting the immediate past into the distant future Herd-like behavior (social proof), driven by a desire to be part of the crowd or an assumption that the crowd is omniscient Misunderstanding randomness; seeing patterns that don’t exist Commitment and consistency bias Fear of change, resulting in a strong bias for the status quo “Anchoring” on irrelevant data Excessive aversion to loss Using mental accounting to treat some money (such as gambling winnings or an unexpected bonus) differently than other money Allowing emotional connections to over-ride reason Fear of uncertainty Embracing certainty (however irrelevant) Overestimating the likelihood of certain events based on very memorable data or experiences (vividness bias) Becoming paralyzed by information overload Failing to act due to an abundance of attractive options Fear of making an incorrect decision and feeling stupid (regret aversion) Ignoring important data points and focusing excessively on less important ones; drawing conclusions from a limited sample size Reluctance to admit mistakes After finding out whether or not an event occurred, overestimating the degree to which one would have predicted the correct outcome (hindsight bias) Believing that one’s investment success is due to wisdom rather than a rising market, but failures are not one’s fault Failing to accurately assess one’s investment time horizon A tendency to seek only information that confirms one’s opinions or decisions Failing to recognize the large cumulative impact of small amounts over time Forgetting the powerful tendency of regression to the mean Confusing familiarity with knowledge
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Overconfidence 1) 2) 3) 4)
19% of people think they belong to the richest 1% of U.S. households 82% of people say they are in the top 30% of safe drivers 80% of students think they will finish in the top half of their class When asked to make a prediction at the 98% confidence level, people are right only 60-70% of the time 5) 68% of lawyers in civil cases believe that their side will prevail 6) Doctors consistently overestimate their ability to detect certain diseases 7) 81% of new business owners think their business has at least a 70% chance of success, but only 39% think any business like theirs would be likely to succeed 8) Graduate students were asked to estimate the time it would take them to finish their thesis under three scenarios: best case, expected, and worst case. The average guesses were 27.4 days, 33.9 days, and 48.6 days, respectively. The actual average turned out to be 55.5 days. 9) Mutual fund managers, analysts, and business executives at a conference were asked to write down how much money they would have at retirement and how much the average person in the room would have. The average figures were $5 million and $2.6 million, respectively. The professor who asked the question said that, regardless of the audience, the ratio is always approximately 2:1 10) 86% of my Harvard Business School classmates say they are better looking than their classmates
Can lead to straying beyond circle of competence and excessive leverage, trading & portfolio concentration Page 9 of 95
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Information and Overconfidence Sometimes additional information can lead to worse decisions, overconfidence and excessive trading •
Heuer study of 8 professional handicappers (set betting odds at horse races) – Moving from 5 most important pieces of data to 40 slightly decreased handicapping accuracy – But doubled their confidence – Similar results with doctors and psychologists – Conclusion: “Experienced analysts have an imperfect understanding of what information they actually use in making judgments. They are unaware of the extent to which their judgments are determined by a few dominant factors, rather than by the systematic integration of all available information. Analysts use much less available information than they think they do."
•
Andreassen study on information overload leading to excessive trading
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Herd-Like Behavior • A “social proof” phenomenon • From 1984 through 1995, the average stock mutual fund posted a yearly return of 12.3% (versus 15.4% for the S&P), yet the average investor in a stock mutual fund earned 6.3%. That means that over these 12 years, the average mutual fund investor would have made nearly twice as much money by simply buying and holding the average mutual fund, and nearly three times as much by buying and holding an S&P 500 index fund. • Over the same period, the average bond mutual fund returned 9.7% annually, while the average investor in a bond mutual rose earned 8% annually – A far narrower gap than equity funds – Bonds are easier to value and thus bond markets are not as susceptible to bubbles and crashes
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A Key Factor in Bubbles Forming: Conforming With the Crowd Conforming with the crowd: the Solomon Asch experiment • 35% of the subjects conformed to the group’s judgment, even though they knew it was wrong, because they were uncomfortable being a minority facing an overwhelming majority • The size of the group didn’t matter • But if even one person gave the correct answer, the subject was far more likely to also give the correct answer
Source: Solomon E. Asch, “Effects of group pressure upon the modification and Distortion of judgment,” in h. Guertzkow, ed., Groups, leadership, and men (Pittsburgh, PA: Carnegie press, 1951).
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More on Bubbles • Overconfidence, social proof, misunderstanding random bunching, overweighting vivid & recent data – lollapalooza effect • Wall Street Journal, 4/30/04: “Speculators do know that it's important to get out, however -- that's the lesson they took away from the cratering of the dot-com highfliers. And they appear to believe that they will be able to get out before a stock craters, as illustrated by numerous trading experiments conducted by Vernon Smith, a professor at George Mason University who shared in the 2002 Nobel Prize for economics. In these experiments, participants would trade a dividend-paying stock whose value was clearly laid out for them. Invariably, a bubble would form, with the stock later crashing down to its fundamental value. Participants would gather for a second session. Still, the stock would exceed its assigned fundamental value, though the bubble would form faster and burst sooner. "The subjects are very optimistic that they'll be able to smell the turning point," says Mr. Smith. "They always report that they're surprised by how quickly it turns and how hard it is to get out at anything like a favorable price." But bring the participants back for a third session, and the stock trades near its fundamental value, if it trades at all, the professor's studies show.”
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Loss Aversion • People feel pain of loss twice as much as they derive pleasure from an equal gain • Case study: two six-sided dice, A and B. A is marked 1-1-1-1-1-13. B is marked 2-2-2-2-2-2. People prefer B, though expected value of A is higher (3 vs. 2) – Helps to be brain damaged
• Case study: Refusal to sell at a loss – Philip Fisher, Common Stocks and Uncommon Profits: “There is a complicating factor that makes the handling of investment mistakes more difficult. This is the ego in each of us. None of us likes to admit to himself that he has been wrong. If we have made a mistake in buying a stock but can sell the stock at a small profit, we have somehow lost any sense of having been foolish. On the other hand, if we sell at a small loss we are quite unhappy about the whole matter. This reaction, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process. More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous.” Page 14 of 95
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Commitment • “A study done by a pair of Canadian psychologists uncovered something fascinating about people at the racetrack: Just after placing a bet, they are much more confident of their horse’s chances of winning than they are immediately before laying down that bet. The reason for the dramatic change is…our nearly obsessive desire to be (and to appear) consistent with what we have already done. Once we have made a choice or taken a stand, we will encounter personal and interpersonal pressures to behave consistently with that commitment. Those pressures will cause us to respond in ways that justify our earlier decision.” – Influence • Leads to information distortion. "Information that is consistent with our existing mindset is perceived and processed easily. However, since our mind strives instinctively for consistency, information that is inconsistent with our existing mental image tends to be overlooked, perceived in a distorted manner, or rationalized to fit existing assumptions and beliefs. Thus, new information tends to be perceived and interpreted in a way that reinforces existing beliefs.” – Grizelda and Beth study • Example of commitment and also “brains have a remarkable talent for reframing suboptimal outcomes to see setbacks in the best possible light. You can see it when high-school seniors decide that colleges that rejected them really weren't much good.” • Case study: “I made a big mistake in not selling several of our larger holdings during The Great Bubble. If these stocks are fully priced now, you may wonder what I was thinking four years ago when their intrinsic value was lower and their prices far higher. So do I.” – Warren Buffett, 2003 Berkshire Hathaway annual report • One of the great dangers of speaking/writing publicly about one’s positions. Page 15 of 95
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Anchoring • Anchoring on purchase price – “When I bought something at X and it went up to X and 1/8th, I sometimes stopped buying, perhaps hoping it would come back down. We’ve missed billions when I’ve gotten anchored. I cost us about $10 billion [by not buying enough Wal-Mart]. I set out to buy 100 million sharers, pre-split, at $23. We bought a little and it moved up a bit and I thought it might come back a bit – who knows? That thumb-sucking, the reluctance to pay a little more, cost us a lot.” -- Buffett – Selling Denny’s at different prices • Anchoring on historical price (or typical price) – Refusal to buy a stock today because it was cheaper last year or has a high price per share (Berkshire Hathaway) – Refusal to sell because it was higher in the past • Anchoring on historical perceptions – Dell is a commodity box maker or MBIA is a triple-A company • Anchoring on initial data/perceptions – Restaurant descriptions experiment • Anchoring on meaningless numbers – Taversky and Kahneman study: spin the wheel and estimate the percentage of countries in the UN that are African Page 16 of 95
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Learning the Wrong Lessons by Misunderstanding Randomness • Confusing making money with making a good decision – Chris Davis’s 5-bagger mistake – Munger’s example of oil executives congratulating themselves • Confusing losing money with making a bad decision – Calculated risks are OK – Bob Rubin’s example of politics (from In an Uncertain World) • Pecking pigeon experiment
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Other Mistakes • Mental accounting – Invest speculatively with “found money” or small amounts of money • Holocaust payments – There is no such thing as “house money” • Emotional connections – Paying more for a new car when upgrading – I like McDonald’s food; Cantalupo’s gift to my children – Discount on Cutter & Buck clothing (reciprocity) – Becoming friends with management • Fear of uncertainty • Embracing certainty (however irrelevant) – The future is uncertain and hard to predict, where as the past is known – Focus on stock charts (irrelevant)
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Other Mistakes (2) • Vividness bias – “People tend to underestimate low probability events when they haven’t happened recently, and overestimate them when they have.” – Buffett – Panic after WorldCom and Enron blew up – Projecting the immediate past into the distant future ¾Buffett: Driving while “looking into the rear-view mirror instead of through the windshield.” ¾Cisco in March 2000, McDonald’s in March 2003 • Worrying about what others will think – Klarman: “As a money manager, it’s potentially embarrassing and painful to have to explain to your investors why you own a name that went into bankruptcy. So the temptation is to just get rid of it.” • Paralysis resulting from too many choices – Experiment: Selling jams in a supermarket – My failure to act in July and October, 2002… – …and finally acting in March 2003 • The near-miss phenomenon – Slot machines – Lynch: “Long shots almost never pay off” Page 19 of 95
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Other Mistakes (3) • Status quo bias and endowment effect – Inheritance study – Thaler’s coffee mugs experiment • $5.25 vs. $2.75 for a $6 mug – Picking cards out of a deck experiment • Valuing a card worth $1.92 for $1.86 or $6.00 or $9.00 • Self-interest bias – Descarte: Man is incapable of understanding any argument that interferes with his revenue – Mutual fund scandal • Munger: “It’s as if someone approached you and said, ‘Let’s murder your mother and split the life insurance proceeds 50/50.’” – Hedge funds swinging for the fences • Failing to consider second- and third-order consequences – Legislation mandating small class sizes • Regret aversion – Failing to act (see next slide) Page 20 of 95
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Failing to Act • Failing to Buy – Status quo bias – Regret aversion – Choice paralysis – Information overload – Hope that stock will go down further (extrapolating recent past into the future; greed) or return to previous cheaper price (anchoring) – Regret at not buying earlier (if stock has risen) • Office Depot at $8 (vs. $6) • Failing to Sell – Status quo bias – Regret aversion – Information overload – Endowment effect – Vivid recent evidence (if stock has been rising) – Don’t want to sell at a loss (if stock has been falling) – If I didn’t own it, would I buy it? Or, If the stock dropped 25%, would I enthusiastically buy more?
Not to decide is a decision Page 21 of 95
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Tips to Applying Behavioral Finance • Be humble – Avoid leverage, diversify, minimize trading • Be patient – Don’t try to get rich quick – A watched stock never rises – Tune out the noise – Make sure time is on your side (stocks instead of options; no leverage) • Get a partner – someone you really trust – even if not at your firm • Have written checklists; e.g., my four questions: – Is this within my circle of competence? – Is it a good business? – Do I like management? (Operators, capital allocators, integrity) – Is the stock incredibly cheap? Am I trembling with greed? • Actively seek out contrary opinions – Try to rebut rather than confirm hypotheses; seek out contrary viewpoints; assign someone to take opposing position or invite bearish analyst to give presentation (Pzena’s method) – Use secret ballots – Ask “What would cause me to change my mind?” Page 22 of 95
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Tips to Applying Behavioral Finance (2) • Don’t anchor on historical information/perceptions/stock prices – Keep an open mind – Update your initial estimate of intrinsic value – Erase historical prices from your mind; don’t fall into the “I missed it” trap – Think in terms of enterprise value not stock price – Set buy and sell targets • Admit and learn from mistakes – but learn the right lessons and don’t obsess – Put the initial investment thesis in writing so you can refer back to it – Sell your mistakes and move on; you don’t have to make it back the same way you lost it – But be careful of panicking and selling at the bottom • Don’t get fooled by randomness • Understand and profit from regression to the mean • Mental tricks – Pretend like you don’t own it (Steinhardt going to cash) – Sell a little bit and sleep on it (Einhorn) Page 23 of 95
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Recommended Reading (in rough order of priority)
• Poor Charlie’s Almanack • Influence, Robert Cialdini • Why Smart People Make Big Money Mistakes, Belsky and Gilovich • The Winner’s Curse, Thaler • Irrational Exuberance, Shiller • Against the Gods: The Remarkable Story of Risk, Bernstein • See overview of the field at http://www.investorhome.com/psych.htm
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Berkshire Hathaway: A High-Quality, Rapidly Growing 75-Cent Dollar History • Berkshire Hathaway today does not resemble the company that Buffett bought into during the 1960s • Berkshire was a leading New England-based textile company, with investment appeal as a classic Ben Graham-style “net-net” • Buffett took control of Berkshire on May 10, 1965 • At that time, Berkshire had a market value of about $18 million and shareholder's equity of about $22 million
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The Berkshire Hathaway Empire Today 6 Largest Stakes in Public Companies
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The Basics • • • • • •
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Stock price (10/8/08): $118,000 – $3,930 for B shares Shares outstanding: 1.55 million Market cap: $183 billion Total assets (Q2 ‘08): $278 billion Total equity: $118 billion Book value per share: $76,129
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Recent Performance of Key Business Units By Year:
2004
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2005
2006
2007
Insurance Group: Premiums Earned GEICO General Re Berkshire Reinsurance Group Berkshire H. Primary Group Investment Income Total Insurance Oper. Inc.
970 1,221 3 -334 417 -1,069 161 235 2,824 3,480 4,375 3,533
1,314 523 1,658 340 4,316 8,151
1,113 555 1,427 279 4,758 8,132
Non-Insurance Businesses: Finance and Financial products McLane Company Shaw Industries MidAmerican/Utilities/Energy Other businesses Total Non-Insur. Oper. Inc.
584 228 466 237 1,787 3,302
822 217 485 523 1,921 3,968
1,157 229 594 1,476 2,703 6,159
1,006 232 436 1,774 3,279 6,727
Total Operating Income
7,677
7,501 14,310 14,859 -4-
Recent Performance of Key Business Units By Quarter:
Insurance Group: Premiums Earned GEICO General Re Berkshire Reinsurance Group Berkshire H. Primary Group Investment Income Total Insurance Oper. Inc. Non-Insurance Businesses: Finance and Financial products Marmon McLane Company MidAmerican/Utilities/Energy Shaw Industries Other businesses Total Non-Insur. Oper. Inc. Total Operating Income
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Q1 2005
Q2 2005
Q3 2005
Q4 2005
Q1 2006
Q2 2006
Q3 2006
Q4 2006
Q1 2007
Q2 2007
Q3 2007
Q4 2007
Q1 2008
Q2 2008
407 308 295 325 335 158 312 358 237 314 311 288 186 298 169 30 230 157 138 19 43 -389 -7 71 106 177 42 102 553 356 183 335 143 140 -1,635 283 94 137 735 692 29 79 154 49 63 77 90 18 37 -10 190 35 43 108 25 81 851 900 942 1,018 1,102 1,103 1,093 1,078 1,236 1,217 1,227 1,089 1,204 787 1,279 1,429 -897 1,722 1,529 1,676 2,530 2,416 2,005 2,210 1,969 1,948 1,371 1,764
199
199
207
217
251
343
69 59 53 36 55 56 141 100 141 141 418 278 88 139 145 113 155 169 514 486 557 430 671 364 861 1,011 1,032 1,064 1,309 1,517 2,140 2,440
282
281
242
277
273
214
68 58 72 50 52 50 416 364 513 372 481 408 132 91 111 125 109 138 916 632 904 895 848 686 1,572 1,761 1,536 1,736 1,824 1,631
241 254 28 261 73 68 516 329 51 82 721 874 1,630 1,868
135 2,786 2,838 3,193 4,102 4,177 3,541 3,946 3,793 3,579 3,001 3,632
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The Earnings of Berkshire’s Operating Businesses Have Grown at a Very High Rate – And Growth is Accelerating
Year 1965 1979 1993 2007
Per-Share Investments $4 $577 $13,961 $90,343
CAGR 42.8% 25.6% 14.3%
Per-Share Pre-Tax Earnings $4 $18 $212 $4,093
CAGR 11.1% 19.1% 23.5%
Berkshire is becoming less of an investment company and more of an operating business.
Note: CAGR: 1965-1979, 1979-1993, 1993-2007. EPS is pretax and net of minority interests. Page 30 of 95
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Berkshire Is One of the Fastest Growing Large Companies in the World Company Exxon Mobil General Electric Wal-Mart Stores Microsoft Berkshire Hathaway Procter & Gamble Petroleo Brasileiro Johnson & Johnson BHP Billiton Chevron AT&T IBM Cisco Pfizer Coca-Cola ConocoPhillips Hewlett-Packard Pepsico GlaxoSmithKline Schlumberger Intel Oracle Genentech Verizon Abbott Laboratories
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Market Cap $413,495 $264,817 $234,858 $229,718 $227,729 $211,072 $207,595 $195,587 $186,523 $180,383 $179,324 $161,023 $142,899 $125,045 $121,862 $119,016 $118,194 $114,581 $114,209 $108,815 $108,111 $103,602 $97,405 $94,830 $90,504
Growth Rate* 22.5 9.2 10.5 20.2 30.5 16.8 16.0 9.4 49.4 25.5 24.1 8.6 14.1 5.1 8.3 30.8 23.9 11.0 4.9 40.0 14.3 19.1 49.1 1.2 6.8
* 5-year compound annual growth rate of EBIT (earnings before interest and taxes) through Q3 07. Berkshire’s figure is pre-tax EPS excluding all income from investments.
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Valuing Berkshire “Over the years we've…attempt[ed] to increase our marketable investments in wonderful businesses, while simultaneously trying to buy similar businesses in their entirety.” – 1995 Annual Letter “In our last two annual reports, we furnished you a table that Charlie and I believe is central to estimating Berkshire's intrinsic value. In the updated version of that table, which follows, we trace our two key components of value. The first column lists our per-share ownership of investments (including cash and equivalents) and the second column shows our per-share earnings from Berkshire's operating businesses before taxes and purchase-accounting adjustments, but after all interest and corporate expenses. The second column excludes all dividends, interest and capital gains that we realized from the investments presented in the first column.” – 1997 Annual Letter
“In effect, the columns show what Berkshire would look like were it split into two parts, with one entity holding our investments and the other operating all of our businesses and bearing all corporate costs.” – 1997 Annual Letter Page 32 of 95
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Buffett’s Comments on Berkshire’s Valuation Lead to an Implied Multiplier of Approximately 12 Pre-tax EPS Excluding All Year-End Investments Income From Stock Intrinsic Implied Year Per Share Investments Price Value Multiplier 1996 $28,500 $421 $34,100 $34,100 13 1997 $38,043 $718 $46,000 $46,000 11 1998 $47,647 $474 $70,000 $54,000 13 1999 $47,339 -$458 $56,100 $60,000 • • • •
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1996 Annual Letter: “Today's price/value relationship is both much different from what it was a year ago and, as Charlie and I see it, more appropriate.” 1997 Annual Letter: “Berkshire's intrinsic value grew at nearly the same pace as book value” (book +34.1%) 1998 Annual Letter: “Though Berkshire's intrinsic value grew very substantially in 1998, the gain fell well short of the 48.3% recorded for book value.” (Assume a 1520% increase in intrinsic value.) 1999 Annual Letter: “A repurchase of, say, 2% of a company's shares at a 25% discount from per-share intrinsic value...We will not repurchase shares unless we believe Berkshire stock is selling well below intrinsic value, conservatively calculated...Recently, when the A shares fell below $45,000, we considered making repurchases.”
T2 Partners LLC
-9-
Applying the 12 Multiple: 2001 – 2007
Year End 2001 2002 2003 2004 2005 2006 2007
Investments Per Share $47,460 $52,507 $62,273 $66,967 $74,129 $80,636 $90,343
Pre-tax EPS Excluding All Intrinsic Income From Value Investments* Per Share -$1,289 $64,000 $1,479 $70,000 $2,912 $97,000 $3,003 $103,000 $3,600 $117,300 ** $5,200-$5,400 143,000-144,400 $5,500-$5,700 *** 156,300-158,700
Subsequent Year Stock Price Range $59,600-$78,500 $60,600-$84,700 $81,000-$95,700 $78,800-$92,000 85,700-$114,200 107,200-151,650 ?
* Unlike the table on page 4 of the 2007 Annual Report, we include earnings from Berkshire’s insurance businesses. ** Actual result was $6,492, but we reduce this to assume the 2nd-worst year ever for super-cat losses. *** Actual result was $6,270 but we reduce the pre-tax, pre-investment-income margins of the insurance businesses by 400 basis points (from 14% to 10%) to reflect Buffett’s guidance in the Annual Report. Page 34 of 95
T2 Partners LLC
-10-
Berkshire Is At Least 25% Below Intrinsic Value, Near the Most Undervalued It’s Been in the Past 12 Years Intrinsic value based on YE 2007 estimate of $157,000, which doesn’t factor in this year’s events, most importantly likely gains from $50+ billion of investments & commitments
Intrinsic Value*
* Investments per share plus 12x pre-tax earnings per share (excluding all income from investments) for the prior year.
Page 35 of 95
T2 Partners LLC
-11-
Valuation Approach #2: Pro-Forma Earnings
• •
• • •
Page 36 of 95
Market cap: $183B 2007 company earnings: approximately $11.5B – adjusted for normal super-cat losses and pricing, and for unusually high capital gains in 2007 Plus 2007 estimated look-through after-tax earnings after cash distributions: $2.2B Equals total pro-forma earnings of $13.7B P/E: $183B / $13.7B = 13.4x
T2 Partners LLC
-12-
Buffett Is Putting Berkshire’s Money to Work Rapidly Does not include $4.7B for Constellation Energy, $5B for Goldman, $3B for GE & others
12 10
$B
8 6 4 2 0 (2)
1996 1997 1998
1999 2000
2001 2002 2003
2004 2005
2006 2007 H1 08
(4) (6) Acquisitions
• •
Net Stock Purchases
He’s doing a good job – but the cash is coming in so fast! – A high-class problem Markets have a way of presenting big opportunities on short notice – Current chaos, junk bonds in 2002; cheap blue-chip stocks in 2005-07 – Buffett has reduced average maturity of bond portfolio so he can act quickly
Page 37 of 95
T2 Partners LLC
-13-
12-Month Investment Return • • • • •
Page 38 of 95
T2 Partners LLC
Current intrinsic value: $157,000/share Plus 10% growth of intrinsic value of the business Plus cash build over next 12 months: $6,000/share Equals intrinsic value in one year of $178,700 51% premium to today’s price
-14-
Catalysts • • • •
Page 39 of 95
T2 Partners LLC
Continued earnings growth of operating businesses New equity investments Additional cash build Potential for more meaningful acquisitions and investments – If the credit crunch continues or worsens, this becomes more likely
-15-
Risks • • • •
• •
Page 40 of 95
Major recession impacts earnings Recent investments turn out badly No catalysts – Intrinsic value will likely continue to grow nicely Buffett’s health – In good health; turned 78 last Aug. 30th – Strong board and succession plan in place – Little Buffett premium in stock today Major super-cats Can’t find place to invest cash – Not a problem currently – There are worse things than sitting on a lot of cash – Buffett has said Berkshire will distribute cash if he doesn’t think he can allocate it
T2 Partners LLC
-16-
Conclusion • •
Page 41 of 95
T2 Partners LLC
Cheap stock: 75-cent dollar, giving no value to redent investments and immense optionality Extremely safe: huge cash and other assets provide downside protection
-17-
Fairfax Over the Past Five Years
Page 42 of 95
T2 Partners LLC
-2-
Fairfax Is a Diversified Insurance Holding Company
Page 43 of 95
T2 Partners LLC
-1-
Fairfax and Its Primary Subsidiaries Had a Great 2007 and Growth and Underwriting Trends Have Been Strong for Many Years
1. Crum and Forster 6 month 2008 results include 20.6 points related to a reinsurance commutation and a reinsurance settlement. Source: Page 44 of 95Fairfax presentation, 9/08
T2 Partners LLC
-3-
Following is a summary of Fairfax's financial results for the third quarter and first nine months of 2008 and 2007:
THREE MONTHS ENDED NINE MONTHS ENDED ---------------------------------SEPTEMBER 30 SEPTEMBER 30 ----------------------(unaudited -$ millions, except per share amounts) 2008 2007 2008 2007 ------------------2,155.1 1,871.2 5,791.2 5,076.3
Total revenue Earnings before income taxes and non-controlling interests Net earnings Net earnings per share Net earnings per diluted share
Page 45 of 95
731.6 467.6
501.0 253.2
1,835.3 1,127.0
1,125.6 532.2
$25.40
$14.12
$60.63
$29.54
$25.27
$13.47
$59.89
$28.27
Combined ratios of the company's insurance and reinsurance operations were as follows for the third quarter and first nine months of 2008 and 2007:
THREE MONTHS ENDED -----------------SEPTEMBER 30 -----------------------
Insurance Reinsurance
Canada (Northbridge) U.S. (Crum & Forster) Asia (Fairfax Asia) - OdysseyRe - Other
Consolidated
2008 ------113.3% 128.5% 85.0% 113.0% 111.9%
2007 ----
115.5%(2)
2007 ----
88.5% 96.5% 68.0% 97.9% 94.6%
2008 ------103.9% 121.8%(1) 80.6% 103.6% 104.5%
94.8%
107.4%(1)(2)
94.3%
(1) Excluding the impact of Crum & Forster's reinsurance commutation in the second quarter and Crum & Forster's lawsuit settlement in the first quarter, the combined ratios in the first nine months of 2008 were 107.6% and 104.2% for Crum & Forster and Fairfax respectively. (2) Prior to giving effect to catastrophe losses related to Hurricanes Ike and Gustav in the third quarter of 2008, the consolidated combined ratios were 93.2% and 99.8% in the third quarter and the first nine
months respectively.
Page 46 of 95
NINE MONTHS ENDED ----------------SEPTEMBER 30 -----------------------
89.6% 95.3% 82.6% 96.1% 95.5%
Fairfax Has Made Enormous Strides Over the Past Year
Page 47 of 95
T2 Partners LLC
-4-
Fairfax’s Financial Strength Has Improved Dramatically
Source: Fairfax presentation, 9/08 Page 48 of 95
T2 Partners LLC
-5-
Fairfax’s CDS Portfolio Has Paid Off In a Big Way – And We Think There’s More Upside As the Credit Crunch Worsens As of 9/19/08, Fairfax had harvested more than $1.85 billion in cash from its CDS portfolio since mid-2007, representing gains of $1.65 billion. It had $12.9 billion notional amount of credit default swaps, valued at $685M remaining. Its 23 CDS positions include (in descending order): AIG, Societe Generale, Fannie Mae, Freddie Mac, XL Capital, Barclays, Goldman Sachs, Genworth, MGIC, ACE, Washington Mutual, Swiss Re, Bank of America and PMI.
Page 49 of 95
T2 Partners LLC
-6-
($ millions)
FY Q1 Q2 Q3 Q4
2007 2008 2008 2008 to October 24
Cumulative sales since inception Remaining credit default swap positions at October 24, 2008 Total realized and unrealized from inception
Notional amount
Original acquisition cost
Sale Proceeds
Excess of sale proceeds over original acquisition cost
965.5 3,830.0 855.0 3,580.9 1,793.2 -------
25.7 95.5 22.8 59.4 38.1 ----
199.3 885.0 190.0 595.7 179.7 -----
173.6 789.5 167.2 536.3 141.6 ------
11,024.6
241.5
2,049.7
1,808.2
9,834.7 -------
191.5 -----
20,859.3 --------
433.0 -----
596.1 (1) -----
2,645.8 -------
404.6(2) -----
2,212.8 -------
(1) Market value as of October 24, 2008 (2) Unrealized gain (measured using original acquisition cost) as of October 24, 2008 The company has sold $11.02 billion notional amount of credit default swaps since inception with an original acquisition cost of $241.5 million for cash proceeds of $2.05 billion and a cumulative gain (measured using original acquisition cost) of $1.81 billion. As of October 24, 2008, the remaining $9.83 billion notional amount of credit default swaps had a market value of $596.1 million and an original acquisition cost of $191.5 million, representing an unrealized gain (measured using original acquisition cost) of $404.6 million. As of October 24, 2008, total cash proceeds realized from the sale of credit default swaps was $2.05 billion, compared to the total original acquisition cost (the aggregate acquisition cost of the credit default swaps sold and the remaining credit default swaps) of $433.0 million.
Page 50 of 95
Hamblin Watsa’s Investment Performance Has Been Spectacular
Page 51 of 95
T2 Partners LLC
-7-
Fairfax Has an Extraordinary Long-Term Track Record of Value Creation
Page 52 of 95
T2 Partners LLC
-8-
Fairfax Is Trading At a Low Multiple of Book Value, Even If the Entire CDS Portfolio is Excluded • • • • • •
Price (11/4/08): $283.65 Market cap: $4.96 billion Tangible book value (Q3 08): $4.56 billion ($261/share) P/B: 1.09 Tangible book value minus entire CDS portfolio of $596 million as of 10/24/08 (assume 30% tax rate): $4.14 billion ($237/share) P/B (adjusted): 1.20
Summary: We think Fairfax’s core business is worth 1.3-1.5x book value, so at today’s price, we’re getting a very good, growing insurance company at a good price, with a free call option on Fairfax’s CDS portfolio.
Note: Page 53 of 95 Tangible book value excludes preferred stock and goodwill. T2 Partners LLC
-9-
Target Over the Past Two Years
Page 54 of 95
$5,272
$5,069
$4,323
$3,601
$3,159
$63,367
$59,490
$52,620
$46,839
$42,025
Financial Highlights – Continuing Operations
22% 7% 71%
Total Revenues (millions) 2007 Growth %: 6.5% Five-year CAGR: 11.1%
Earnings Before Interest Expense and Income Taxes (EBIT) (millions) 2007 Growth %: 4.0%
($4.4 billion)
• New Stores • Remodels & Expansions • Information Technology, Distribution & Other
$3.33
$3.21
$2.71
$2.07
$1.76
$2,849
$2,787
$2,408
$1,885
$1,619
Five-year CAGR: 13.4%
2007 Capital Expenditures
22% 34% 22% 19% 3%
Earnings from Continuing Operations (millions)
Diluted EPS
2007 Growth %: 2.2%
Five-year CAGR: 17.1%
Five-year CAGR: 15.7%
Page 55 of 95
2007 Growth %: 3.9%
2007 Sales Mix
($61.5 billion)
• Consumables & Commodities • Electronics, Entertainment, Sporting Goods & Toys • Apparel & Accessories • Home Furnishings & Décor • Other
2007 Sales Per Capita
Y E A R - E N D S T O R E C O U N T A N D S Q U A R E F O O TA G E B Y S TAT E Sales per Capita Group
No. of Stores
Retail Sq. Ft. (in thousands)
38 71 4 113
5,615 10,032 554 16,201
45 225 115 82 21 18 32 7 14 15 8 136 49 767
5,800 28,836 15,701 11,035 2,855 2,450 4,082 780 1,934 1,863 1,023 18,580 6,425 101,364
16 2 51 32 30 57 33 38 9 45 18 4 28 11 34 34 442
2,093 268 6,845 4,207 3,803 6,690 4,321 4,925 1,024 5,852 2,166 417 3,464 1,679 3,968 4,042 55,764
Sales per Capita Group
Alabama Idaho Louisiana New York Ohio Oklahoma Pennsylvania Rhode Island South Carolina Group Total
$201– $300 Arizona California Florida Illinois Iowa Kansas Maryland Montana Nebraska Nevada New Hampshire Texas Virginia Group Total
Page 56 of 95
18 6 13 58 63 10 47 3 18 236
2,554 664 1,853 7,718 7,798 1,455 6,039 378 2,224 30,683
0 6 0 12 4 4 0 5 2 33
0 745 0 1,383 503 489 0 626 187 3,933
1,591
207,945
$0 – $100 Alaska Arkansas Hawaii Kentucky Maine Mississippi Vermont West Virginia Wyoming Group Total
$151– $200 Connecticut Delaware Georgia Indiana Massachusetts Michigan Missouri New Jersey New Mexico North Carolina Oregon South Dakota Tennessee Utah Washington Wisconsin Group Total
Retail Sq. Ft. (in thousands)
$101– $150
Over $300 Colorado Minnesota North Dakota Group Total
No. of Stores
Total
Sales per capita is defined as sales by state divided by state population.
15
Financial Summary – Continuing Operations
2007 Financial Results: (in millions) Sales Credit card revenues
2006(a)
2005
2004
2003
2002
$61,471 1,896
$57,878 1,612
$51,271 1,349
$45,682 1,157
$40,928 1,097
$36,519 891
Total revenues
63,367
59,490
52,620
46,839
42,025
37,410
Cost of sales Selling, general and administrative expenses (b) Credit card expenses Depreciation and amortization
41,895 13,704 837 1,659
39,399 12,819 707 1,496
34,927 11,185 776 1,409
31,445 9,797 737 1,259
28,389 8,657 722 1,098
25,498 7,505 629 967
Earnings from continuing operations before interest expense and income taxes (c) Net interest expense
5,272 647
5,069 572
4,323 463
3,601 570
3,159 556
2,811 584
Earnings from continuing operations before income taxes Provision for income taxes
4,625 1,776
4,497 1,710
3,860 1,452
3,031 1,146
2,603 984
2,227 851
$ 2,849
$ 2,787
$ 2,408
$ 1,885
$ 1,619
$ 1,376
$ $ $
$ $ $
$ $ $
$ $ $
$ $ $
$ $ $
Earnings from continuing operations Per Share: Basic earnings per share Diluted earnings per share Cash dividends declared Financial Position: (in millions) Total assets Capital expenditures Long-term debt, including current portion Net debt (d) Shareholders’ investment Financial Ratios: Revenues per square foot (e)(f) Comparable-store sales growth (g) Gross margin rate (% of sales) SG&A rate (% of sales) EBIT margin (% of revenues) Other: Common shares outstanding (in millions) Cash flow provided by operations (in millions) Retail square feet (in thousands) Square footage growth Total number of stores General merchandise SuperTarget Total number of distribution centers
3.37 3.33 .54
3.23 3.21 .46
2.73 2.71 .38
2.09 2.07 .31
1.78 1.76 .27
1.52 1.51 .24
$44,560 $ 4,369 $16,590 $15,238 $15,307
$37,349 $ 3,928 $10,037 $ 9,756 $15,633
$34,995 $ 3,388 $ 9,872 $ 8,700 $14,205
$32,293 $ 3,068 $ 9,538 $ 7,806 $13,029
$27,390 $ 2,738 $11,018 $10,774 $11,132
$24,506 $ 3,040 $11,090 $10,733 $ 9,497
$
$
$
$
$
$
318 3.0% 31.8% 22.3% 8.3%
818.7 $ 4,125 207,945 8.3% 1,591 1,381 210 32
316 4.8% 31.9% 22.2% 8.5%
859.8 $ 4,862 192,064 7.7% 1,488 1,311 177 29
307 5.6% 31.9% 21.8% 8.2%
874.1 $ 4,451 178,260 8.0% 1,397 1,239 158 26
294 5.3% 31.2% 21.4% 7.7%
890.6 $ 3,808 165,015 8.2% 1,308 1,172 136 25
287 4.4% 30.6% 21.2% 7.5%
911.8 $ 3,188 152,563 8.8% 1,225 1,107 118 22
281 2.2% 30.2% 20.5% 7.5%
909.8 $ 2,703 140,294 11.9% 1,147 1,053 94 16
(a) Consisted of 53 weeks. (b) Also referred to as SG&A. (c) Also referred to as EBIT. (d) Including current portion and short-term notes payable, net of marketable securities of $1,851, $281, $1,172, $1,732, $244 and $357, respectively. Management believes this measure is a more appropriate indicator of our level of financial leverage because marketable securities are available to pay debt maturity obligations. (e) Thirteen-month average retail square feet. (f) In 2006, revenues per square foot were calculated with 52 weeks of revenues (the 53rd week of revenues was excluded) because management believes that these numbers provide a more useful analytical comparison to other years. Using our revenues for the 53-week year under generally accepted accounting principles, 2006 revenues per square foot were $322. (g) See definition of comparable-store sales in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
16
Page 57 of 95
Target : Investors : Financial News Release
http://investors.target.com/phoenix.zhtml?c=65828&p=irol-newsArticle...
Financial News Release Investors
Financial News Release
Target Corporation September Sales up 2.5 Percent 10/08/08 MINNEAPOLIS--(BUSINESS WIRE)-Target Corporation (NYSE:TGT) today reported that its net retail sales for the five weeks ended October 4, 2008 increased 2.5 percent to $5,320 million from $5,190 million for the five weeks ended October 6, 2007. On this same basis, September comparable store sales declined 3.0 percent. "Sales for the month of September were below our expectations, reflecting continued daily volatility," said Gregg Steinhafel, president and chief executive officer of Target Corporation. "Challenges in the current environment, including weak top-line growth in our retail segment and higher net write-off rates in our credit card segment, have increased the likelihood that our third quarter EPS may be slightly below the current First Call median estimate of 52 cents. On balance, we currently expect 2008 full year earnings per share to meet or exceed last year's full year EPS of $3.33." This outlook for 2008 EPS assumes essentially flat year-over-year same store sales in the fourth quarter and a continuation of recent write-off rate trends through the remainder of this year. All earnings per share figures refer to diluted earnings per share. Sales
Total Sales Comparable Stores % Change --------------------------
(millions)
% Change
This Year
Last Year
---------- ----------- ---------------- --------September
$
5,320
2.5
(3.0)
1.2
Quarter-to-date
$
10,172
2.8
(2.6)
3.5
Year-to-date
$
39,445
4.7
(1.1)
4.3
Target's current sales disclosure practice includes a sales recording on the day of the monthly sales release. Consistent with this practice, a new message was recorded earlier today. The next sales recording is expected to be issued on Thursday, November 6, 2008. These recordings may be accessed by calling 612-761-6500. Forward-looking statements in this release regarding expected earnings per share results should be read in conjunction with the cautionary statements in Exhibit (99)A to the company's first quarter 2008 Form 10-Q. Target Corporation's retail segment includes large, general merchandise and food discount stores, and a fully integrated on-line business called Target.com. In addition, the company operates a credit card segment that offers branded proprietary and Visa credit card products. The company currently operates 1,685 Target stores in 48 states. Target Corporation news releases are available at www.target.com. Source: Target Corporation
©2008 Target.com. All rights reserved. The Bullseye Design and Target are registered trademarks of Target Brands, Inc.
Page 58 of 95
1 of 1
11/5/2008 11:36 AM
Target : Investors : Earnings Estimates
http://investors.target.com/phoenix.zhtml?c=65828&p=irol-estimates
Earnings Estimates Investors
Earnings Estimates
Glossary Analyst Ratings 1-Strong Buy
Mean Recommendation: 2.8
2
2-Buy
4
3-Hold
12
4-Underperform
1
5-Sell
1
Sell
Strong Buy
Analyst Forecasts Last Month's Revisions Fiscal Period
Mean
High
Low
Median
# of Estimates
#Up
#Down
Mean % Change
Annual
Jan 11
3.82
4.32
2.78
3.94
7
0
4
-13.56
Annual
Jan 10
3.48
4.14
2.70
3.45
22
0
16
-6.32
Annual
Jan 09
3.32
3.50
3.10
3.31
22
0
19
-2.99
Quarterly
Oct 08
0.50
0.54
0.46
0.50
20
1
15
-4.72
Quarterly
Jan 09
1.27
1.42
1.19
1.27
18
0
16
-5.66
Quarterly
Apr 09
0.72
0.85
0.63
0.72
12
0
8
-7.46
Quarterly
Jul 09
0.83
0.95
0.77
0.83
12
0
8
-5.71
12.95
16.00
7.50
14.00
10
0
0
-3.45
Long Term Growth
Actuals Reported EPS
Mean Estimate
Surprise % Change
Annual
Jan 08
3.33
3.34
-0.31
Quarterly
Oct 07
0.56
0.62
-9.14
Quarterly
Jan 08
1.23
1.22
0.52
Quarterly
Apr 08
0.74
0.71
4.93
Quarterly
Jul 08
0.82
0.76
8.61
Annual
Jan 07
3.21
3.18
0.84
Annual
Jan 06
2.71
2.70
0.55
Data Provided by Thomson Financial
Find out which investment firms prepare and publish research on Target Corporation
©2008 Target.com. All rights reserved. The Bullseye Design and Target are registered trademarks of Target Brands, Inc.
Page 59 of 95
1 of 1
11/5/2008 11:37 AM
Unlocking Immense Real Estate Value REITs, private market ground leases, and inflation-protected securities all trade at much higher valuation multiples than Target’s multiple, at only 6.0x ‘09E EV/EBITDA, based on a 20-day trading average stock price of $40 Target’s Market Valuation (1)
Inflation Protected Securities / REIT Market Valuations
2009E EV / EBITDA
2009E EV / EBITDA
6.0x
15.7x
17.0x
33.3x
$40/Share (1)
Large Cap REITs (1)
Recent “Big Box” Ground Lease (2)
Inflation Protected Treasury Securities (TIPS) (3)
The Transaction creates immense and instant value because 22% of Target’s current EBITDA will be valued at a significantly higher multiple than where Target trades today (1) Based on a 20-day trading average as of 10/24/08 (2) Based on mid-point precedent cap rate of 5.9% (3) Based on current 20-year TIP yield of 3.0% Page 60 of 95
19
Target: Retail and Real Estate Operations
Retail Operations
Real Estate Operations ■ High-quality owned real estate in attractive suburban and urban locations
■ Iconic U.S. retail brand ■ Best-in-class operator with distinctive merchandising strategy
■ Significant value embedded in real estate, not accounted for in public market valuation
■ 1,685 stores in 48 states ■ Best management team in the retail industry
■ Owns ~95% of its retail buildings and ~85% of the land under its retail locations
■ Attractive growth profile, driven by mid-tohigh single-digit square footage growth and market share gains
■ Owns ~84% of its distribution centers (“DCs”) and ~81% of the land under its DCs
■ Recently sold an undivided interest in credit card receivables
Page 61 of 95
■ Facilities Management Services comprising hundreds of employees responsible for property maintenance 8
Significant Real Estate Ownership Target owns the highest percentage of its real estate compared to other big box retailers 100
95%
92% 87%
% Units Owned (Buildings)1
90
87%
80 68%
70
63%
60
58%
50 40
34%
34%
30 20 10 0
% owned units/land(2): 85%
79%
ND
ND
55%
ND
35%
ND
27%
% DCs owned(3):
ND
2%
84%
76%
55%
89%
54%
ND
84%
“ND” represents Not Disclosed (1) Represents % owned stores (includes owned stores on leased land) (2) Represents % owned stores on owned land only Page 62 of(3) 95 Represents % owned DCs (includes owned DCs on leased land)
9
Selected 2009E Income Statement Data Based on the assumptions provided, the Transaction would result in $1.4bn EBITDA in 2009E to TIP REIT 2009E
2009E
2009E
Target Corp
TIP REIT
"Combined"
2009E Target Standalone
($mm, except per share)
EBITDA
(1)
$5,172
$1,427
$6,599
D&A
1,884
56
1,940
1,940
EBIT
3,288
1,372
4,659
4,674
Taxes
1,004
7
EPS
$2.23
$1.79
(2)
$6,614
1,011
1,528
$4.02
$3.40
22% of total EBITDA to TIP REIT Minimal D&A at TIP REIT and no maintenance capex
TIP REIT pays almost no taxes
18% EPS accretion from tax efficiencies and improved free cash flow (1) Includes incremental $15mm of standalone costs at TIP REIT (2) Normalized to exclude $112mm (approximately $0.16/share) of incremental interest expense due to CY2009 cash E&P distribution Page 63 of 95
26
Valuation Summary Based on the assumptions provided and using the mid-point of the valuation analysis, this Transaction would result in total combined value of $70 per share for Target shareholders (74% premium to the 20-day average trading price) and $83 per share twelve months later
$83 $80
$70 TIP REIT
$/Share
$60
$40
$20
74% $40 Target Standalone
TIP REIT
$42
$38 Target Corp Target Corp
$32
$42
$0 Target (20-Day Avg. Price) ¹
Target REIT Spin-Off ²
12-Month Price Target ²
For illustrative purposes, assumes Transaction occurs on 01/01/09 (1) Based on a 20-day trading average as of 10/24/08; assumes sale of remaining 53% interest on credit card business with proceeds used to pay down debt (2) Based on mid-point of valuation analysis 30
Page 64 of 95
MBIA Over the Past Two Years
Page 65 of 95
Who Are the Bond Insurers? Financial Guarantors are inadequately capitalized to withstand a negative credit event 100x
94.1x 80.8x
75x
Face Value Bond Guarantees / Statutory Capital
50x
25x
0x
Reserves / Guarantees Page 66 of 95
3.15 bps
3.93 bps 37
Growing Structured Finance Exposure MBIA Structured Finance Guarantees as a % of total Guarantees have more than doubled over the past 10 Years
2006
1996 Structured Finance
Structured Finance
14% 68%
86%
Public Finance
Page 67 of 95
Public Finance
39
32%
Growing Structured Finance Exposure MBIA has increased exposure to Structured Finance during period of rapid innovation and lower lending standards MBIA: Net Par Insured 75.0%
70 59.5
60
66.5% 47.6
50
$ insured (bn)
46.7
42.1 53.0%
40 30
55.0%
25.2 44.3%
20
65.0%
45.0%
42.1%
38.7%
35.0%
10 25.0%
0
2003 Page 68 of 95
2004
2005 40
2006
Q1 '07
% of total
MBIA Compared to Citigroup
Credit Rating
Aaa, AAA
Aaa, AA+
Regulator
NYS Insurance Dept
Federal Reserve, OCC, FDIC
Leverage
94:1
12:1
(Net Par / Capital)
(Risk Adj. Assets / Tier 1 Capital)
Credit Exposure
$635 billion
$1,107 billion
Capital
$6.8 billion
$127.0 billion
3 bps
96 bps
Reserves / Credit Exposure Page 69 of 95
41
Minimal Losses Will Impair MBIA’s Capital Base Total Guaranteed Portfolio Public Finance Structured Finance
$ 635.2 Billion 421.8 $ 213.4 Billion
CDO Exposure Mortgage Exposure Other ABS Exposure Direct and Pooled Corporate Exposure Total Structured Finance Exposure
108.6 52.0 26.9 25.9 $ 213.4 Billion
Estimated "Excess" Capital over AAA (1) Losses to eliminate excess capital
$
0.5 Billion 23 bps
Total Statutory Capital Base SF Losses to eliminate all capital
$
6.8 Billion 316 bps
(1) Excess Capital estimate assumes $1.5B of excess capital at 12/06 reduced by two $500M dividends in 12/06 & 4/07
Page 70 of 95
42
MBIA Is One of the Most Profitable US Companies? “We have the highest profit margin of any financial company in the Forbes 500 with over a billion in sales.” --Joseph W. Brown, Chairman of MBIA Net Income Margins of Several Highly Profitable Companies
Page 71 of 95
Source: Company reports, Pershing estimates (MBI adjusted for one-time expenses). 49
Decreasing Unallocated Reserves MBIA’s unallocated reserves, expressed in bps of net par outstanding, have dwindled to only 3.2 basis points of total exposure (as of 3/31/07) MBIA’s Unallocated Reserves (bps of net par outstanding)
7.0
6.2bps
6.0bps
6.0
5.7bps
5.5bps
5.4bps
5.0
bps
4.0
3.6bps
3.5bps 3.2bps
3.0
2.0
1.0
2000 Page 72 of 95
2001
2002
2003 50
2004
2005
2006
Q1 '07
MBIA Has Enormous Exposure to CDOs and Risky Mortgages Impairments Net Par CDO Exposure (Net of Reinsurance) Outstanding ($B) Taken ($B) Collateral Type CDOs of High-Grade U.S. ABS $15.1 $0.54 CDOs of Mezzanine U.S. ABS $3.4 $0.06 CDO-Squareds $8.6 $0.44 Other Multi-Sector CDOs $2.4 Investment Grade and Structured Corporate Credit $42.6 5% impairment vs. High Yield Corporate $10.9 70% Ambac took CMBS and Commercial Real Estate $42.2 Emerging Market $0.2 77% originated in 2006-07; 55% was with Countrywide, CDO Total $125.4 $1.04 28% Rescap RMBS Exposure Prime First Lien (incl. $3.5 billion of Alt-A) $14.7 HELOCs and Closed-End Seconds $17.8 Sub-Prime First Lien $4.1 Total Direct RMBS: Net Par Outstanding $36.6 $1.12 GRAND TOTAL $162.0 $2.16
Note: All figures as of 6/30/08. Funds managed by T2 Partners LLC are short MBIA. Source: MBIA Q2 08 investor presentation.
Page 73 of 95
T2 Partners LLC
-1-
MBIA’s Structured Finance Insured Portfolio Poses Many Problems, Given That MBIA Has a Mere $4 Billion in Equity
Source: MBIA Q2 08 investor presentation – appendix. Page 74 of 95
T2 Partners LLC
-2-
Insured Portfolio Losses and Impairments $ in millions 4Q07
1Q08
2Q08
3Q08
Total
Formula provision
$ 23
$ 23
$ 22
$ 22
$ 90
Additional loss and LAE
814
265
0
961
2,040
GAAP incurred loss and LAE
837
288
22
983
2,130
RMBS payments
44
108
305
491
948
Other payments
25
10
26
5
66
Total payments
69
118
331
496
1,014
$ 1,264
$ 1,435
$ 1,258
$ 1,806
N/A
$ 200
$ 827
$ 13
$ 57
$ 1,097 ,
Loss Prevention Expenses
0
1
2
5
8
Total Payments
0
0
0
0
0
$ 200
$ 828
$ 15
$ 62
$1 1,105 105
Ending net loss reserves and LAE
Credit impairments p
T t l credit Total dit impairments i i t + LPE
8 Page 75 of 95
RMBS Portfolio Second Lien Incurred Loss Estimate Increased to $2.1 $2 1 billion •RMBS Related Loss Estimates • ($ in billions) $2.5
21 2.1
$2.0 $1.5
1.1
$1 0 $1.0 $0.5 $0.0 MBIA Loss Estimates 3/31/08
MBIA Revised Loss Estimates 9/30/08
Expected Losses Increased due to: • Increase in early stage delinquencies from Q2 combined with steady roll-rates • Minimal evidence of loan modifications by servicers • Monthly losses in Q3 peaking higher than original forecasts • As of 9/30/2008, MBIA has reserves on 72.6% of the second-lien net par exposure • 73% of total Loss Reserves related to Countrywide and ResCap litigation
22 Page 76 of 95
Direct RMBS Exposure Sector and Vintage Composition $ in billions Q2 2008
Q3 2008
41 4.1
40 4.0
14.7
13.0
HELOCs
8.2
7.7
Closed-End-Seconds
9.6
9.0
$ 36.6
$ 33.7
Subprime First Lien Prime First Lien (Alt-A of $3.5 billion included)
Total Direct RMBS: Net Par Outstanding
Portfolio Vintage Composition ($ in billions as of 9/30/2008) 2007 2006 2005 2004 Pre-2004
10 9 8 7 6 5 4 3 2 1 -
HELOC
CES
U.S. Subprime
International
Alt-A
Prime 1st Mtge
•
HELOCs and CES are predominantly 2005 & 2006 and 2006 & 2007 vintages, respectively
•
International exposure is primarily to Financial Institutions capital relief and covered bond transactions/$1.6 billion natural amortization this quarter
20 Page 77 of 95
CES and HELOC Performance Trends •Weighted Average CDRS •(source: Intex) 14%
HEL 3mo CDR
12%
CES 3mo CDR
• Cumulative Default Rates have continued to increase each month
10% 8% 6% 4% 2% 0% Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep07 07 07 08 08 08 08 08 08 08 08 08
•Change C in 30-59 Delinquency
• In Q2, the early–stage delinquencies started reducing slightly, but in Q3 they increased by over 12%
•(source: Intex) 14% 12% 10% 8% 6% 4% 2% 0% -2%
1Q08 vs 4Q07
2Q08 vs 1q08
3Q08 vs 2Q08
23 Page 78 of 95
An Analysis of One CDO and One RMBS That MBIA Is Exposed To
Page 79 of 95
Where Did All of These Toxic Loans End Up? They Were Securitized, First Into Asset-Backed Securities (ABS) Quick Review: What is a Securitization?
Source: Deutsche Bank Securitization Research; “How to Save the Bond Insurers”, Pershing Square presentation, 11/28/07. Page 80 of 95
T2 Partners LLC
-72-
Tranches from Asset-Backed Securities Were Pooled into Collateralized Debt Obligations (CDOs)
Loss rates of, say, 20%, in the underlying RMBS’s can lead to catastrophic losses for a CDO
This is an example of a “Mezzanine CDO.” A “High-Grade CDO” would select collateral primarily from the A and AA tranches mixed with ~25% senior tranches from other, often mezzanine, CDOs Note: Asset-based securities backed by home mortgages are called Residential Mortgage-Backed Securities (RMBS), those backed by commercial real estate loans are called Commercial Mortgage-Backed Securities (CMBS), etc. Source: Citigroup, All Clogged Up: What’s Ailing the Financial System, 2/13/08.
Page 81 of 95
T2 Partners LLC
-73-
A Closer Look at MBIA’s Multi-Sector CDO Exposure Note: This chart is from Pershing Square’s Open Source Model, released on 1/30/08. Subsequently, MBIA’s Q1 ’08 showed that MBIA’s multi-sector CDO exposure totals $30.7 billion. CDOs of High Grade U.S. ABS were $16.0 billion as of 3/31/08; CDOs of Mezzanine U.S. ABS were $3.6 billion (due to $2.5 billion of exposure from 2000-2003 not included in this chart); CDO Squareds were $8.6 billion; plus there were $1.1 billion of “Multi-Sector CDOs European Mezzanine & Other Collateral” and $1.4 billion of “Multi-Sector CDOs insured in the Secondary Market prior to 2005”. Page 82 of 95
T2 Partners LLC
-10-
A Closer Look at One CDO Whose Senior Tranche Is Guaranteed by MBIA
• • •
Page 83 of 95
MBIA has guaranteed the most senior tranche of the Longshore CDO MBIA’s potential liability is $1.13 billion (before reinsurance) The most senior tranche originally had 13% credit enhancement (CE), totaling $169 million, meaning MBIA has no liability until the CDO suffers losses of this amount – However, MBIA is on the hook for 100% of the losses (before reinsurance) above this – As of 3/31/08, losses in this CDO had reduced the credit enhancement to only 4.4% and MBIA projects 83% default of “inner CDO collateral”
T2 Partners LLC
Sources: Pershing Square, Amherst Holdings LLC.
-11-
A Closer Look at the Longshore 2007-III CDO More than half of the Longshore CDO is backed by tranches from RMBS pools, more than half of which are subprime. The balance of Longshore is roughly equally split between tranches of CMBS pools and other CDOs (i.e., 23% of Longshore is a CDO-squared).
RMBS tranches account for 53.5% of Longshore’s total value, or $683 million. These tranches are from RMBS pools with total assets of $27.5 billion. The tranches on average are 3.1% thick and have 13.6% credit enhancement.
Page 84 of 95
T2 Partners LLC
Sources: Pershing Square, Amherst Holdings LLC.
A Look at 35 of the 90 RMBS’s Underlying the Longshore CDO Prepayments have reduced the value of this pool from $1.099 billion to $818 million (under $800 million currently)
Source: Amherst Holdings LLC., spring 2008 data Page 85 of 95
T2 Partners LLC
-13-
1 of the 90 RMBS Tranches Underlying the Longshore CDO: The M5 Tranche of the ABFC 2006-OPT2 Trust Tranche (M5) Owned by Longshore CDO
There was 8.45% credit enhancement when this RMBS was created, but this has risen to 11.32% thanks to prepayments Page 86 of 95
T2 Partners LLC
Source: Amherst Holdings LLC.
There is $79.3 million beneath it
There are 471 basis points of yearly excess interest available to absorb losses (because homeowners pay a higher interest rate than the Trust does) -14-
The ABFC 2006-OPT2 Trust is in Big Trouble •
The average loan is only 25 months old and most loans have only just begun to hit their reset date – $526 million of loans (66.8% of the remaining pool) had interest rate resets in July and August, 2008
•
Despite this, the Trust is already in big trouble: – – – – – –
•
5.9% of the loans are 30 days delinquent 2.1% are 60 days delinquent 2.3% are 90 days delinquent 18.3% are in foreclosure and 9.0% are real estate owned 3.9% are homeowners in bankruptcy
Thus, 29.5% are 90 days delinquent or worse – Up from 23.8% six months ago – Virtually all of these loans will result in the home being auctioned – On average, it takes 15 months from the date of the first missed payment to the liquidation event (auction) – Recoveries are averaging 45-55% – Losses to date have only been $27.3 million (up from $9.5 million a mere six months ago)
Source: Page 87 of 95 Amherst Holdings LLC.
T2 Partners LLC
-15-
Characteristics of the ABFC 2006-OPT2 Trust • • • • • • • •
41.4% of loans are in states hit hardest by the bursting of the housing bubble: California, Nevada, Florida and Arizona Only 15.7% of performing loans are fixed rate 41.0% are low/no doc 62.1% are refi (cash out), 31.0% are purchases, 6.9% are refi (no cash out) No loans are insured Of loans 90 days or more delinquent, 45.1% are green, 28.2% are yellow and 26.7% are red Of performing loans (including 30 and 60 day delinquencies), 61.5% are green, 18.3% are yellow and 20.3% are red Once loans become delinquent, few become current again. For loans made in 2005 and 2006: – 55% of 30 day delinquent loans become 60 days delinquent – 75% of 60 day delinquent loans become 90 days delinquent – An even higher percentage of 90 day delinquent loans go into foreclosure and REO
Source: Amherst Holdings LLC. Page 88 of 95
T2 Partners LLC
-16-
Distribution of the Remaining, Performing Loans in the ABFC 2006-OPT2 Trust Low/No Doc Loans
Full Doc Loans FICO/CLTV
0 - 65
65 - 70
70 - 75 75 - 80 80 - 85 85 - 90 90 - 95 95 - 100
FICO/CLTV
0 - 65
65 - 70 70 - 75 75 - 80 80 - 85 85 - 90 90 - 95 95 - 100
700 - 1100
0.1%
0.1%
0.1%
0.1%
0.3%
0.5%
0.1%
2.1% 700 - 1100
0.1%
0.1%
0.1%
0.2%
0.2%
0.7%
0.1%
1.9%
680 - 700
0.1%
0.0%
0.0%
0.0%
0.1%
0.3%
0.2%
0.9%
680 - 700
0.1%
0.1%
0.4%
0.0%
0.2%
0.2%
0.1%
0.9%
660 - 680
0.1%
0.2%
0.1%
0.0%
0.4%
0.4%
0.2%
0.9%
660 - 680
0.3%
0.0%
0.0%
0.2%
0.5%
0.6%
0.7%
0.9%
640 - 660
0.2%
0.2%
0.1%
0.4%
0.8%
0.8%
0.7%
1.3%
640 - 660
0.3%
0.0%
0.8%
0.6%
0.6%
1.0%
0.4%
1.2%
620 - 640
0.7%
0.4%
0.6%
0.4%
1.3%
1.0%
0.6%
2.6%
620 - 640
0.2%
0.3%
0.4%
0.3%
1.1%
1.0%
0.6%
0.6%
600 - 620 580 - 600
0.2% 0.4%
0.3% 0.5%
1.0% 0.5%
0.2% 0.7%
1.7% 1.4%
0.9% 1.8%
0.1% 0.4%
3.3% 5.9%
600 - 620 580 - 600
0.2% 0.5%
0.3% 0.3%
0.6% 0.4%
0.7% 0.6%
1.3% 1.1%
0.4% 0.8%
0.1% 0.2%
0.4% 0.3%
560 - 580 540 - 560
0.4% 0.2%
0.5% 0.5%
0.5% 0.2%
0.4% 0.4%
1.0% 0.4%
1.1% 0.4%
0.1% 0.1%
2.5% 0.1%
560 - 580 540 - 560
0.4% 0.4%
0.3% 0.2%
0.3% 0.2%
0.5% 0.1%
0.4% 0.6%
0.1% 0.0%
0.0% 0.0%
0.1% 0.0%
520 - 540
0.6%
0.4%
0.5%
0.9%
1.3%
0.8%
0.3%
1.7%
520 - 540
0.5%
0.4%
0.4%
0.5%
1.3%
0.7%
0.3%
0.5%
500 - 520 480 - 500
0.3% 0.4%
0.3% 0.3%
0.5% 0.1%
0.4% 0.2%
0.9% 0.3%
0.5% 0.6%
0.0% 0.1%
0.1% 0.9%
500 - 520 480 - 500
0.4% 0.1%
0.1% 0.2%
0.2% 0.1%
0.1% 0.2%
0.6% 0.6%
0.0% 0.3%
0.0% 0.2%
0.0% 0.2%
460 - 480 0 - 460
0.0% 0.1%
0.0% 0.0%
0.0% 0.3%
0.0% 0.3%
0.0% 0.5%
0.0% 0.4%
0.0% 0.0%
0.0% 0.6%
460 - 480 0 - 460
0.0% 0.1%
0.0% 0.1%
0.0% 0.2%
0.0% 0.1%
0.0% 0.4%
0.0% 0.1%
0.0% 0.4%
0.0% 0.1%
Total Full Doc:
60.2%
Total Low Doc: 39.8%
Source: Amherst Holdings LLC. Page 89 of 95
T2 Partners LLC
-17-
S&P’s Projected Lifetime Delinquency Rates for Loans With Characteristics of Those Remaining in the ABFC 2006-OPT2 Trust
Full Doc Loans (60.2% of the Trust) FICO/CLTV 700 - 1100
0 - 65 65 - 70 70 - 75 75 - 80 80 - 85 85 - 90 0.4% 0.8% 0.3% 1.5% 1.6% 1.6%
Low/No Doc Loans (39.8% of the Trust)
90 - 95 95 - 100 FICO/CLTV 1.2% 1.8% 700 - 1100
0 - 65 65 - 70 70 - 75 75 - 80 80 - 85 85 - 90 0.5% 1.1% 0.8% 1.4% 1.6% 2.7%
90 - 95 95 - 100 4.0% 3.3%
680 - 700
1.2%
0.7%
0.0%
1.5%
1.1%
1.7%
2.5%
2.8% 680 - 700
1.1%
1.0%
1.5%
0.0%
4.3%
3.4%
3.7%
4.8%
660 - 680
1.5%
1.0%
2.6%
3.6%
2.3%
3.8%
2.9%
3.9% 660 - 680
1.8%
1.1%
0.0%
2.0%
2.2%
3.3%
4.2%
6.9%
640 - 660
1.4%
1.4%
1.8%
2.3%
2.3%
4.7%
3.9%
6.6% 640 - 660
1.7%
1.6%
2.2%
2.3%
2.5%
6.2%
3.7%
10.5%
620 - 640
4.0%
2.7%
4.6%
3.4%
4.3%
7.0%
8.4%
8.0% 620 - 640
3.6%
3.5%
4.1%
5.0%
5.4%
9.0%
8.9%
19.6%
600 - 620
4.8%
4.9%
7.5%
5.2%
9.3%
7.6%
11.2%
11.0% 600 - 620
9.4%
6.2%
9.0%
7.2%
7.6%
10.1%
19.7%
19.3%
580 - 600
6.9%
9.1%
9.4%
9.3%
9.6%
11.0%
15.0%
15.6% 580 - 600
13.7%
8.1%
10.6%
15.3%
13.5%
21.0%
20.8%
28.0%
560 - 580
7.1%
11.6%
8.7%
8.1%
11.9%
15.8%
14.8%
17.8% 560 - 580
7.4%
13.4%
14.3%
10.1%
11.2%
19.9%
16.1%
30.0%
540 - 560
12.4%
12.4%
9.2%
10.1%
15.4%
15.6%
21.6%
19.2% 540 - 560
16.7%
7.3%
13.2%
15.0%
15.2%
11.9%
27.7%
0.0%
520 - 540
13.7%
11.5%
19.9%
16.7%
16.3%
22.3%
20.5%
26.1% 520 - 540
15.2%
14.9%
21.0%
26.3%
18.5%
43.8%
28.8%
30.0%
500 - 520
11.0%
11.0%
12.9%
12.2%
16.8%
19.9%
17.0%
18.9% 500 - 520
11.5%
12.0%
14.0%
21.8%
20.7%
17.3%
0.0%
0.0%
480 - 500
18.8%
17.4%
17.0%
20.1%
27.8%
22.2%
27.9%
18.0% 480 - 500
23.5%
20.7%
30.0%
25.1%
41.9%
29.5%
49.6%
56.0%
460 - 480
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0% 460 - 480
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
17.7%
74.6%
18.0%
19.7%
19.5%
24.5%
20.3%
18.1%
19.6%
39.6%
24.3%
25.7%
30.0%
33.7%
30.0%
0 - 460
18.4%
0 - 460
The 23.8% defaults in the first 25 months are only the tip of the iceberg Source: Amherst Holdings LLC. Page 90 of 95
T2 Partners LLC
-18-
Conclusions Regarding the M5 Tranche of the ABFC 2006-OPT2 Trust •
•
•
•
The M5 tranche owned by the Longshore CDO is 2.75% thick and is senior to 11.3% of the Trust (there is only $79.3 million subordinate to this tranche; down from $92.0 six months ago) In only 25 months, the Trust has already lost $27.3 million and has $280 million in defaults – in total, an expected accumulated loss of $140mm (assuming a 50% loss on the defaulted loans) $140 million is $60.7 million more than the $79.3 million subordinate to the M5 tranche – and there are 335 months to go and the bulk of the loans have just hit their reset date Thus, we believe that it is nearly certain that 100% of this tranche will be wiped out – Yet Moody’s still has it rated B3 (S&P and Fitch have cut it to CCC) (funds managed by T2 Partners LLC are short Moody’s)
•
Page 91 of 95
Amherst Securities is pricing a tranche like this as the present value of 1-2 years of interest payments only (i.e., at most, 4-7 cents on the dollar)
T2 Partners LLC
-19-
Implications for the Longshore CDO •
We believe that the M5 tranche of the ABFC 2006-OPT2 Trust is fairly typical of the RMBS tranches that account for 53.5% of the value of the Longshore CDO, based on the data in the default, foreclosure, REO and credit enhancement columns of the table on page 13 – If so, most are worthless, but a few might end up being worth something, so let’s assume a 2/3 loss, which equals 35% of Longshore (2/3 of 53.5%)
•
The CMBS pools, the tranches of which account for 25% of Longshore, are not showing any losses (in part because they are all recent 2006 and 2007 vintage) – The CMBS market is currently under tremendous stress, but to be conservative, let’s assume no losses (though there surely will be some)
•
•
As for CDO-squareds, which account for 23% of Longshore, if CDOs like Longshore are severely impacted, then CDO-squareds (which in Longshore’s case have a weighted thickness of 14.2%; see lower chart on page 12), are worthless In summary, we estimate that Longshore will incur losses of 55-60% of the original collateral of $1.3 billion, or $720-$780 million – This is in the ballpark of the $649 million loss estimated in Pershing Square’s Open Source Model
Page 92 of 95
T2 Partners LLC
-20-
Implications for MBIA’s Guarantee of the Longshore CDO •
•
If our estimate is correct that Longshore will incur losses of $720-$780 million, then after subtracting the credit enhancement of $169 million (see page 11), MBIA faces gross losses of $551-$611 million MBIA has reinsured 20.9% of Longshore (see page 10), which would result in net losses of $436-483 million – However, we doubt that MBIA’s CDO reinsurance is worth much, given that 53% of MBIA’s reinsurance and a higher percentage of its CDO reinsurance is with Channel Re, a captive reinsurer that we believe is insolvent (its majority owners wrote down their stake in Channel Re to zero earlier this year)
MBIA has taken only $602.7 million in impairments (3.3%) against its $18.5 billion of exposure to CDOs of High-Grade and Mezzanine U.S. ABS *
* MBIA has, however, taken $2.1 billion in mark-to-market losses on its CDOs of High-Grade and Mezzanine U.S. ABSs, which it claims will be reversed over time. Page 93 of 95
T2 Partners LLC
-21-
MBIA May Have Trouble Collecting on Much of Its Reinsurance
Source: MBIA Q2 08 investor presentation – appendix. Page 94 of 95
T2 Partners LLC
-22-
Implications for MBIA and Ambac • •
MBIA has $29.5 billion of exposure to multi-sector CDOs Based on the analysis on the preceding pages, we believe that the loss estimates in Pershing Square’s Open Source Model are likely to be conservative:
Open Source Model Summary of MBIA’s Projected Losses Collateral Type ABS CDOs Closed End Seconds * HELOCs * Direct Subprime * Direct Alt/A * Total
Page 95 of 95
T2 Partners LLC
Loss to Net Par Loss to Gross Par Insured Insured $5,737,633,669 $6,665,622,522 $2,809,578,386 $2,809,578,386 $2,948,599,126 $2,948,599,126 $8,503,314 $8,503,314 $129,499,794 $129,499,794 $11,633,814,290 $12,561,803,143
-23-
