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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: Michael Burry who wrote (4471)	7/23/1998 10:43:00 PM
From: James Clarke	Read Replies (1) \| Respond to of 78711

re: USEC (USU) Mike has just boiled down an incredibly complex prospectus to a simple analysis. I am honestly shocked because I know how long it took me to get to that point. And I didn't see it until I interviewed management one-on-one. Mike, great job, and you're getting close. You have the facts just as I see them, but let me take you one step further. Hopefully this exchange is helping others understand this unique business as well - wouldn't want to just have a one on one exchange on everybody else's time. First, you need to discount the inventories - don't use market value ($45 per kg of raw uranium - 1000 kg per metric ton, and $95 per SWU of enriched uranium). Yeah, I am being conservative. The uranium is 60% of a year's global demand, so clearly they can't sell it without destroying the market price. The market price is $45 a kg. Maybe you already did that because you used $35. I used a 30% discount, so maybe we got to the same point. The flaw I perceive in your analysis (which remember, got to the share price as a decent value with a dividend) is that you're not separating the core business, which earns $2 a share in free cash flow, from the "hidden asset". These are completely independent of each other. You are subtracting all the liabilities of the company from the asset. But that asset has nothing to do with the liabilities. Put the uranium and SWU inventories aside, the business stands on its own and earns that $2. So I feel very comfortable saying, "what is the least $2 of stable but not growing free cash flow is worth?" With interest rates below 6%, that's $18-20. Then I add to that the $7+ (I think you can see now how conservatively I am valuing those excess inventories) to get to $25-27. Your analysis double-counts a billion of liabilities. The stock trades at 14 1/4 with an 8% yield. Is the yield safe? The payout ratio is very high based on trailing earnings. Now the hidden asset starts to become very important. Management is going to liquidate those inventories, about $150 million a year. What happens when you sell inventories which are on the balance sheet for half their market price? a) its pure free cash flow, net of a tax hit (over $1 a share) - there's your dividend safety, plus a huge share buyback if the business is as stable as I think it will be; and b) for every kg of uranium liquidated, they book about $14 of earnings. ($40 per kg market price - $20 per kg book value)*(1 - tax rate). Voila - this no growth business will show growing earnings - remember, this earnings source is not in the trailing numbers. Now how about more? Government operations are not notorious for being run efficiently. The VP of manufacturing told me face-to-face last week that he can cut $50 million of cost easily, and that is just the start. Of course unions will be an obstacle to anything extreme, but there is low-hanging fruit here. Take that $50 million, tax it at 40% - that's $30 million of incremental earnings. Give it a 10 P/E and there's another $3 per share. That is not in my valuation - those are bonus points. I made USEC my largest investment today, and will double it when I get a feel for which way it's going to trade (I'm dreaming of a sell-off to 12, because NOBODY seems to understand what this business is worth). I have enough conviction in my analysis that I am actually hoping the largest stock in my portfolio drops 20% so I can buy the rest at lower prices. And I will do so without hesitation. Sorry for the long post, but as Mike found out, this one is not simple. But once the light bulb goes off ("ding!") it becomes very simple. If you intend to research this investment, may I suggest you print out this exchange between Mike and I, read the prospectus, then try to develop the story yourself. Do not buy this unless you do your own homework - hopefully this will be of assistance in sorting out a very complicated story. Respectfully, Jim

To: Michael Burry who wrote (4471)	7/23/1998 11:21:00 PM
From: Scott Mc	Read Replies (2) \| Respond to of 78711

Mike, good to see you back, hope the move went well... Great discussion between James and you on USU, the only thing missing(I dont have the prospectus) is what incentive is their to management to increase value? Reminds me a bit of when CNR was taken public in Canada a few yrs back, no one wanted to touch it at first... Mike, any comment on Phycor? The convert looks very cheap at $74 and from what I know of the company its a quality act, trading 2/3 book and PS/r of 0.5 I own some of the converts looking to increase it.. Tech Value: I'm looking at ANET seriously, I believe the purchase recently of Bay by NTel has raised the bar for other companies such as Ericsson. A potential target could be ANET, never the less its cheap trading at 7 3/8 its under book value, PSr 1.2 and $5 a share in cash...