An Interview with Marty Whitman
sageonline.com
by Morningstar Analysts
| 03-05-01 | 03:00 PM |
Marty Whitman is a vulture of a value investor, usually found rummaging through the rubble of distressed stocks--those of beaten-down companies, some on the brink of insolvency. But most of Whitman's depressed stock plays eventually turn around for the better, and his Third Avenue Value Fund TAVFX, which Whitman has managed since 1990, sports one of the small-value category's top records. The key to Whitmanesque stock-picking: Buy companies that are cheap and safe, and hold onto them.
When you’re looking at the balance sheet of a firm, what do you look for?
We don’t do every company the same way. The first thing we like is a relative absence of liability. On the asset side, we look for high-quality assets. That is cash, or near-cash--things convertible of cash--or assets that can produce a lot of cash flow, whether recorded or not. Now, I have to qualify that we don’t rely heavily on conventional accounting definitions. For example, for accounting purposes, inventory at a retail company like Sears S would be called a current asset, because if the company were liquidated, that inventory would be liquidated within 12 months. However, we look at Sears as a going concern, that is, a fixed asset of the worst possible sort, in that it has to have that amount of investment in inventory if it's going to operate the business. It’s a fixed asset subject to obsolescence, fashion styles, and shrinkage, and that’s why we don’t really consider that an analysis of Sears or any going concern retail chain is tied to current assets. On the other hand, we have a large investment in Forest City Enterprises FCE.A, the best investment-building real-estate company nobody ever heard of. It has a huge, huge amount of fixed assets in the form of income-producing office buildings, shopping centers, multiuse facilities, and residential buildings, most of which can be sold on a telephone call. We consider those very, very high-quality assets.
Do you use any different parameters when it comes to buying debt?
There are many, many differences, but when it comes to debt you are essentially dealing in contract rights, as distinguished from common stock where you’re essentially dealing in economic phenomenon, like earnings predictions or measuring asset values. I think a good example is we bought some Pacific Gas & Electric PCG first mortgages at about a 25% yield. I don’t care what happens to Pacific Gas & Electric. It’s impossible for me to figure out how a first mortgage for that utility won’t be principal to its interest.
Let's talk about USG. Why'd you buy the common stock before the debt?
I suspect that the fund [Third Avenue Value] is the largest creditor of USG USG at the moment. I think we own some $80 million of their senior notes. Again, it's a very, very strong, fine company, but the basic contract right means there is no way creditors would be subordinated to an asbestos claim. So we bought those at an average yield to maturity at 21% and again it's pretty hard to figure out how these things will not be creditworthy.
Still, you bought the stock and then changed your mind. Why?
When I bought the stock it was just a flawed analysis. I figured after all these years people probably have their hands around asbestos liability. But I don’t think now that anybody can get their hands around what ultimate asbestos liability will be. USG is an extremely strong company. The asbestos taint is against only one subsidiary, US Gypsum, and there are two other subsidiaries that have substantial earnings. The stock is a big bargain. But once we can’t know the liabilities, my feeling is it isn't safe. If I have no conception of what the liabilities might be, how can I call the stock safe? We still own a million and a half shares, though.
What about tobacco stocks?
Wouldn’t touch them.
Why not?
Basically, it’s a liability issue. Second, it’s a moral issue. They’re a bunch of lying thieves.
You're interested in the semiconductor/capital equipment area, though.
We’ve been buying semiconductor equipment and related stocks in situations where cash alone exceeds or is close to all book liabilities, where we’re paying under 10 times what past peak earnings had been. The trade-off is we’re willing to live through very severe down cycles, which I think we may have to do. We’ve done it in the past. Business is extraordinarily competitive, extraordinarily cyclical, but given all the pricing parameters and the financial qualities of the businesses, it's very hard to get in trouble. When we originally went into semiconductors in the depression of 1997-98, I thought the prices were as good or better than venture capitalists would pay, like a first-stage venture capitalist.
Have you been attracted at all to less-capital-intensive industries in technology?
Oh sure. Except that less-capital-intensive tends to mean more competition and more ease of entry. We’ve done a few small software things, and I dispute with you whether semiconductor equipment is really capital intensive. It’s research and development intensive--a much bigger part of the expenditure equation.
Would you evaluate the buildup of inventories in those companies the same way you would on the retail side you discussed earlier?
No question. It's a rough period. There's a big decline in the book-to-bill ratio, and I suppose that 2001 is not going to be a good year. The companies we’re in can easily ride out any problems, though. In fact, their strong finances in depressions give them great acquisition opportunities, as compared with people who are financially weak.
Let's talk about financials. Did you ever get interested in Berkshire Hathaway BRK.B about a year, year and a half ago?
A: Yeah, we just never did it.
Why not?
I don't know, I can’t buy everything. Let me spell it out for you, L-A-Z-Y [laugh]. In fairness, a couple of years ago we were suffering massive redemptions and we didn’t have a lot of money to buy anything and there was a lot of stuff we couldn’t buy. We had to sell stuff we didn’t want to sell.
What are you looking at in financials nowadays?
Not a lot. Looking at my open order list, Arch Capital ACGL, an insurance holding company, is the only one we’re buying at the moment.
But you like mutual-fund companies…
Yes.
Have you done anything there lately?
No. We should look again now that we have a bear market. Our big position is Liberty Financial L, which is getting sold. That’s got to be the world’s greatest business: all cash, no credit risk. Not a lot of overhead. I love investing in mutual-fund companies when I can get in at a discount to assets under management. Lately they have been selling at premiums. Our two biggest positions, Legg Mason LM and Liberty Financial, we're not buying now.
What’s a multiple to assets that you’re comfortable with?
We’ll pay 2% of assets under management. Sales prices have been 4% to 5% of assets under management, like when Acorn sold out to Liberty. We try not to pay more than 2% for assets under management.
Overall, what’s interesting you the most right now?
By far, passive-components manufacturers, such as AVX AVX, Kemet KEM, and Vishay VSH. We’re buying them at five and six times earnings. Let me contrast them with semiconductor-equipment firms. These are all cash rich, all huge, huge growth potential, just like semiconductor equipment. The basic dynamics, the long-term growth are the same. There are three things that distinguish them from semiconductors: One, they don’t look like they are going into a deep, deep depression. Earnings this year will be down, but I’m sure they’re selling well under 10 times any forecasted 2001-02 earnings. Two, the industry’s an oligopoly. Third, it looks like the business is an awful lot less cyclical than semiconductors because instead of going into plant and equipment, these are consumer products. They are the guts of cell phones, they are the guts of telephones, they are the guts of computers, so that it looks like they have been and should be less cyclical than semiconductor equipment. And we’re certainly getting in at prices, by my criteria, that ought to be well below what first-stage venture capitalists would pay. |
