ValueInvestor
February 28, 2010
The Leading Authority on Value Investing
Price is Right
Among the keys to successfully managing more than $8 billion in small-cap
assets, says Preston Athey: courage, casting a wide net, and loads of patience.
A
fter graduating from Yale in 1971,
Preston Athey postponed a career in
finance to spend five years in the
Navy, mostly as a speechwriter for Admiral
Hyman Rickover. “Starting out in an envi-
ronment where talented people work hard
for ideals rather than money has been quite
valuable,” he says. “It helps you keep your
eye on the big picture.”
Now managing $8 billion in assets for T.
Rowe Price, Athey has proven as skilled
with the details as he is with the big picture.
The Small-Cap Value mutual fund he took
over in 1991 has returned a net annualized
11.9%, vs. 8.3% for the Russell 2000.
Casting a wide net for value, Athey is
finding it today in such areas as boating,
regional banks, seasonal gifts and informa-
tion-technology distribution. See page 2
The Last 20%
A drive “to understand companies and businesses in the same way managers and
employees do” is producing eye-popping returns for First Wilshire's Scott Hood.
INVESTOR INSIGHT
Scott Hood
First Wilshire Securities
Investment Focus: Seeks companies
whose stock prices don’t adequately reflect
the growth or turnaround potential he sees
or are just “ridiculously cheap.”
INSIGHT
Inside this Issue
F E AT U R E S
Investor Insight: Preston Athey
Casting a wide net for small-cap
INVESTOR INSIGHT bargains and finding them in
Brunswick, Glacier Bancorp, CSS
Industries and GTSI Corp. PAGE 1 »
Investor Insight: Scott Hood
Finding unrecognized or ignored
value in American Water Works,
Imax, Rent-A-Center, Jinpan, and
Motorcar Parts of America. PAGE 1 »
Uncovering Value: Kraft
Market skeptics of it and its Cadbury
acquisition are likely to be dead
wrong, says Bill Ackman. PAGE 19 »
Preston Athey
T. Rowe Price A Fresh Look: Chubb
Investment Focus: Seeks companies Why Tim Hartch believes the market
whose stock charts look “like death warmed hasn’t yet fully recognized how well it
over” from operating or cyclical challenges has weathered the storm. PAGE 21 »
that over time should be overcome.
Strategy: Seth Klarman
The investing great describes some of
the many lessons – real and false –
emanating from the crisis. PAGE 22 »
INVESTMENT HIGHLIGHTS
W
INVESTMENT SNAPSHOTS PAGE
hen asked to what he attributes
American Water Works 14
his firm's success, Scott Hood
Brunswick 5
cites “that last 20%” of the
Chubb 21
research on a company – the grueling
CSS Industries 7
detective work often required to find
unique insights. “There are plenty of Glacier Bancorp 6
dead ends, but sometimes you find the GTSI Corp. 8
buried treasure,” he says. Imax 15
Hood’s treasure-hunting skills are well in Jinpan International 16
evidence: A composite of the First Wilshire Kraft 19
Securities’ portfolios he manages with 87- Motorcar Parts of America 17
year-old company founder Fred Astman has Rent-A-Center 13
earned a net annualized 20.3% over the past
ten years, vs. 3.5% for the Russell 2000. Other companies in this issue:
Primarily focused on small-cap stocks, ATMI, Fred's, Raven Industries, Chindex,
Hood sees an eclectic mix of opportunity Harbin, Companhia de Saneamento
today in areas including rent-to-buy retail, Basico, Atlantic Tele-Network
water, movie projection, auto parts and
electricity transformers. See page 10
www.valueinvestorinsight.com

Investor Insight: Preston Athey
Preston Athey and David Wagner of T. Rowe Price describe why patience can be such a virtue in small-cap investing,
why holding 315 positions makes perfect sense for them, the surprising sector that sports some of today's most inter-
esting bargains, and why they see unrecognized value in Brunswick, Glacier Bancorp, CSS Industries and GTSI Corp.
You consider yourself an “eclectic” value
investor. In what way?
Preston Athey: At the heart of being a
value investor is having a contrarian bent.
Beyond that, though, there are many dif-
ferent flavors of value investing. Tweedy
Browne is a great deep-value investment
firm. Chuck Royce at Royce Funds is a
wonderful GARP [Growth At a
Reasonable Price] practitioner – he’s
focused on value but definitely doesn’t
like to own bad companies. Mason
Hawkins at Southeastern Asset
Management and Marty Whitman of
Third Avenue are oriented toward stocks
trading at significant discounts to net
asset value. Bill Miller is probably best
described as an all-out contrarian.
The fact that all these people have
been successful proves that there’s no sin-
gle way to do it. What the market offers
up as opportunity is constantly changing,
so being able to deploy a variety of strate-
gies as the situation warrants allows us
great flexibility to go almost anywhere
and never get shut out of the market.
That’s important because our investors
don’t ask us to move in and out of cash
depending on how overvalued or under-
valued we think the market is. And
frankly, having an eclectic view makes
investing a lot more interesting.
Even with an eclectic view, is there a typ-
ical situation that attracts you?
PA: I stay closest to the value philosophy
on the purchase side of the ledger. If an
analyst walks in and pitches a wonderful
company growing 20% a year whose
stock trades at 20x earnings and 3.5x
book value, I’ll suggest he pass it on to
our growth fund, because that’s not what
I’m looking for. What will get me excited
is a story like this: “Preston, I’ve been
following this stock for two years but
February 28, 2010
I N V E S T O R I N S I G H T : Preston Athey
haven’t found a good reason to write it
up. It used to be kind of a high-flier, but
the stock chart now looks like death
warmed over. The shares were at $40,
had a big drop and have been trading
between $15 and $18 for months and
nobody cares. The company is likely to
have some big writeoffs this year to clean
up the balance sheet. And, by the way,
two months ago the board fired the CEO
and the new guy is someone I know from
a previous company where he did a great Preston Athey
job. He’s not even talking to the Street
for six months as he gets a handle on In Tune
things.”
In these types of cases we can analyze After joining T. Rowe Price fresh out of
fairly quickly what the company’s poten- Stanford Business School in 1978,
tial is relative to its peers or its own his- Preston Athey was tutored by a variety of
tory, and see how cheap it is relative to managers and in several investment
what we consider to be normal earnings. styles. For a time, he even contemplated
We also like when there’s a catalyst, say, keeping his responsibilities for the firm's
in the form of a new CEO. With large Small-Cap Growth strategy when he was
caps, regression to the mean seems to asked to take over the Small-Cap Value
work often enough after things have Fund in 1991. “The set of stocks and the
gone bad, but in small caps we believe
mindset were just too different to do
identifiable catalysts – like management
both,” he says.
changes, restructurings or maybe indus-
try consolidation – increase the odds of
Athey attributes T. Rowe Price's long-term
winning.
success to a culture that puts the invest-
ment process first. “I can't say it's entirely
Do you put a lot of emphasis on the qual-
unique, but the culture is collaborative,
ity of the business?
with no star system, an emphasis on learn-
ing, and no incentive to climb over some-
PA: Speaking broadly, probably 10% of
one else's back to get ahead,” he says.
the businesses out there are lousy, such as
“It's all about doing the best research pos-
selling pure commodities where the mar-
sible, while minimizing the distractions that
ginal cost of production drives the pricing
might take away from that.”
and companies find it very hard to earn
even the cost of capital over time. I may
One distraction Athey pursues outside of
own such a company from time to time,
work is singing bass for Baltimore a cap-
but it’s rare.
pella group Sum of the Parts. “We all have
At the other end of the spectrum are
another maybe 10% of businesses which fairly accomplished musical resumes, but
are of excellent quality. A perfect example we really just perform for the love of the
would be money management firms, music,” he says. “Of course, if the gig
which in aggregate earn obscene returns includes dinner and libations, we're all the
on equity. We love to own these types of more eager to sign up.”
www.valueinvestorinsight.com Value Investor Insight 2

companies, but the opportunities to buy
them cheaply are relatively few and far
between.
So that leaves us most occupied with
the other 80%, in which there’s a chang-
ing roster of winners and losers. Those
changes in fortunes are typically tied to
cycles and how individual companies are
managed, which are the types of things
we believe we can analyze and judge. In a
lot of our companies, just getting back to
average operating performance can result
in excellent investment results.
How do you define “small cap” in man-
aging your portfolio?
PA: We invest in companies with market
values between $50 million and $1 billion
at the time of purchase. We generally
won’t buy more of anything if the market
cap gets over $2 billion, and I’ll start
moving out of a stock when it gets over
$3 billion.
Where do your ideas tend to come from?
David Wagner: Our analysts are charged
with coming up with ideas, which they
find in any number of ways. Preston grills
them and says no to most of the ideas, but
probably 70% of the positions we buy
make it through that process.
The other 30% of the ideas that end of
up in the portfolio tend to come from
Preston seeking out the analysts whose
sectors have been most beaten into sub-
mission and pushing them – often against
their instincts – to give him names to con-
sider. The analysts are often afraid to
bring him things that have performed ter-
ribly, but that’s exactly what he wants to
hear about.
Do any sectors strike you as particularly
interesting today?
PA: Our rule is to own something in every
sector, in part to avoid missing something
important because it’s out-of-sight, out-
of-mind. We’re not a slave to our bench-
mark – the Russell 2000 Value Index –
but I typically don’t go much below half,
or much above twice, the index weighting
February 28, 2010
I N V E S T O R I N S I G H T : Preston Athey
in any sector. I’ve found that gives us
plenty of room to beat the index, while
avoiding the type of relative volatility that
makes most investors nervous.
As for a specific sector of interest,
we’re actually finding some of the most
compelling bargains today in regional
and community banks. There’s little ques-
tion we’re probably less than halfway
through a weeding out process that will
result in a material fraction of U.S. banks
ON LOW TURNOVER:
It’s driven by the belief that if
you’ve truly done your upfront
research well, you should have
the patience to let ideas work.
going out of business. As that’s going on,
there are a significant number of smaller
banks trading at 75-80% of book value,
where the jury is still out on whether
they’ll make it through. If you’re right in
picking those that do make it through,
there’s an excellent chance you’ll make
two, three or four times your money on
them over the next three years.
Preston, you started out as a technology
analyst. Is that a big part of your portfo-
lio today?
PA: Information technology is a bit over
10% of the portfolio, right around the
weighting in our benchmark, but the
types of things I own would be anathema
to most tech investors. I tend to be
attracted to companies more for their
defensive attributes than offensive. A
good example is ATMI [ATMI], a suppli-
er of materials used primarily in the fab-
rication of semiconductors. It’s in a cycli-
cal business far from the top of the cycle,
has $108 million of net cash and [at a
recent price of just under $17] sells for
only 1.3x book value. It has staying
power and when the cycle turns, it will
earn a lot of money and we expect the
stock to go back above $30, where it has
traded for years in the past.
www.valueinvestorinsight.com
One distinguishing characteristic of your
portfolio is the number of positions – usu-
ally more than 300. Explain the rationale
for that.
PA: Part of it is just the practical reality
of running $8 billion in a small-cap strat-
egy – with that much money, you can’t
hold 50 stocks without moving well out
of small-cap range for many of them.
Another practical consideration is our
investor base, which is retail investors and
large institutions. Performance obviously
matters when they choose T. Rowe Price
to run their small-cap assets, but they also
want to be comfortable that the portfolio
isn’t going to blow up. For many investors
volatility is the enemy of rational invest-
ment decisions, so the less volatile we are,
the more likely our investors won’t sell at
the bottom and buy at the top. Running
with the level of diversification we have,
the standard deviation of our returns has
been lower than that of our benchmark
Russell index.
Philosophically, I find broad diversifi-
cation makes it easier to be a contrarian.
We made the mistake in 2007 of buying
some housing, recreational-vehicle and
mobile-home stocks after they fell 50%,
which clearly turned out to be too early.
But because of the way we run the port-
folio and our recognition of the risks
involved, we never made those holdings,
in aggregate, more than 3% of the portfo-
lio. While that particular out-of-favor bet
hasn’t paid off, it hasn’t hurt us much
either. As long as the potential upside is
high, we should be making those types of
investments and they can make a real dif-
ference when they work.
Another unique aspect of your strategy is
very low turnover. Why is that?
PA: Our turnover is usually in the low
teens – last year it was 8%, versus an
average for small-cap value funds fol-
lowed by Morningstar of around 70%.
This is typical of T. Rowe Price funds,
and is driven by the belief that if you’ve
truly done your upfront research well,
you should have the patience and courage
to let ideas work. I don’t believe you can
Value Investor Insight 3

explain 70% turnover or more without
assuming people are buying many things
they don’t really know and dumping them
when they get a negative surprise. We’re
not immune to missing things, but it’s
rare that unexpected risks come up so
quickly that we reverse course before the
thesis has had a chance to play out.
This obviously only works if you pay
the right price going in, to the point
where the downside is truly low. One of
my favorite examples of patience paying
off is K-Tron [KTII], which we’ve owned
since before I took over the fund in 1991.
The company makes material-handling
equipment and was a typical idea for us:
the stock was exceedingly cheap because
the company was underperforming and
we saw a relatively clear path for the right
management to fix things. The mix of
businesses was decent enough that we
didn’t see things getting much worse, and
the upside was significant.
The problem was that for years noth-
ing much happened, and it took the
board until 1998 to push out the CEO
and turn to one of its members, a lawyer
named Edward Cloues. He started mak-
ing the tough operating decisions and
then began making a series of smart
acquisitions at extremely favorable
prices. The stock eventually went on a
multi-year run that culminated in K-Tron
being bought out in January by
Hillenbrand for $150 per share. Our cost
basis was just over $10.
As the stock went nowhere for years, it
would have been easy to sell it and move
on. But we never lost our conviction there
was something there, just waiting to be
unlocked. Were we stubborn, or maybe
just lucky? Probably a little of both, but
without a willingness to be patient that
most investors don’t have, we would have
missed an incredible run.
It’s impressive you held it the entire way.
Any insights to share about knowing
when to take profits?
PA: I don’t know that there’s a secret to
getting this right. You have to constantly
assess whether the expectations built into
the share price are still reasonable. We
February 28, 2010
I N V E S T O R I N S I G H T : Preston Athey
also pay careful attention to who owns the
stock at any given time. One reason we
pay brokers is for insight into who’s buy-
ing and selling our stocks. When the
momentum buyers who pay more atten-
tion to the stock chart than what the com-
pany does are coming in, it’s high time for
us to be getting out. We may still lose out
on some upside from there, but if the com-
pany misses an earnings number with that
kind of shareholder base, the stock can be
off 50% in a day. That’s not the type of
thing we want to own.
One other relevant point on K-Tron:
this was a small position in a much small-
ON SELLING:
When buyers who pay more
attention to the chart than
what the company does come
in, it’s time for us to get out.
er fund at the outset, so we didn’t have to
sell much on the way up to avoid the rel-
ative position size getting too big.
Do you have a current example of a long-
time-coming idea that you haven’t yet
given up on?
PA: I would put Fred’s [FRED], the dis-
count retailer, in that category. We’ve
owned it for nearly 15 years and after
putting a wide range of credible merchan-
dising and efficiency programs in place,
the company so far hasn’t figured out
how to get the margins that peers like
Family Dollar, Dollar General and Dollar
Tree earn. Fred’s margins could double
and still be below the average for the
industry. If that happened, we’d have a
pretty good stock on our hands. Hope
springs eternal.
Describe the broader investment case for
one of your deeply out-of-favor holdings,
Brunswick [BC].
DW: One general area of opportunity we
see in the market is in consumer discre-
www.valueinvestorinsight.com
tionary companies for which investors
seem to have concluded the typical up-
and-down cycle won’t apply and that
there’s a two-decade secular headwind.
For those companies selling things like
boats and recreational vehicles, if they’ve
cut costs and maintained margins
through bad times that have caused com-
petitors to leave the market, people are
likely to be surprised by how much they
can earn with even a modest increase in
market demand.
Brunswick is a perfect example of this
type of opportunity. Its biggest business –
accounting in normal times for roughly
80% of total revenue – is boating, which
includes the manufacture of both boats
and engines. The profit driver is engines,
in which Brunswick is the clear market
leader in North America with its Mercury
and MerCruiser brands, and in which it
makes a lot of money on aftermarket
parts and service. The remaining 20% of
revenues is split between a fitness divi-
sion, which makes exercise equipment,
and a bowling and billiards unit.
PA: Boat sales have obviously been
extremely depressed. Retail powerboat
sales from 2001 to 2007 averaged around
$10 billion per year, adjusted for infla-
tion. In 2008, that number was less than
$8 billion and in 2009, less than $5 bil-
lion. Unit sales for 15 years before the
crisis averaged around 300,000 per year –
the estimate for last year was less than
150,000.
We’re not going back to 300,000 units
or $10 billion in sales per year any time
soon. But if sales even come halfway back
– 225,000 units and $7.5 billion in over-
all revenues – this should be an excellent
investment.
How would that level of recovery work
through Brunswick’s financials?
PA: We estimate that they’re taking out
$425 million in fixed costs through 2010
– the number of North American plants
has been cut from 28 to 14, while total
headcount is down 37% – and there’s still
more to come out after that from capaci-
ty decisions already made.
Value Investor Insight 4
 I N V E S T O R I N S I G H T : Preston Athey

If retail boat sales recover even 20- DW: There’s been some recognition that we get an unadjusted enterprise value of
25% from the trough, we expect last year looked even worse for the com- $3 billion. After a variety of balance sheet
Brunswick to generate $4.1 billion in rev- pany than it actually was. Brunswick’s adjustments, EV then should be around
enues by 2012. That’s still 25% below production in 2009 was only half its $2.25 billion. That would imply a share
the levels from 2005 to 2007. Given the retail sales, as dealers heavily cut back price in the mid-$20s two years out.
costs they’ve taken out, we’re expecting on orders and sold out of inventory.
operating margins of between 6% and Now dealer inventories are at multi-year What are the primary risks?
7% in 2012, also below the 2005 peak lows and are unlikely to go lower, so
level of 8.4%. All that would translate there’s a significant amount of revenue PA: If our experience in the U.S. becomes
into 2012 earnings before interest, depre- upside this year – roughly 50% in the that of the Japanese lost decade, boat
ciation and amortization of around $400 boat segment – if Brunswick just pro- sales aren’t likely to turn around much. In
million. duces to meet the level of retail sell- addition, if consumer financing remains
through from last year. restricted and people can’t borrow money
The stock is well up from the depths of for things like boats, all bets are off for a
despair last March. What upside do you PA: Looking further out, if we put a 7.5x company like Brunswick.
see from today’s price of around $11.50? multiple on our 2012 EBITDA estimate, We consider other risks to be fairly
limited. We don’t see big competitive
INVESTMENT SNAPSHOT risks, as the company has maintained or
increased market shares through the
Brunswick downturn. We don’t see financial risk –
(NYSE: BC) Valuation Metrics
(@2/26/10):
they’ve trimmed their debt and are build-
Business: Global recreational-products
BC S&P 500 ing cash. We don’t see operational risk, as
manufacturer operating in three primary
lines of business: boats/boat engines, fit- Trailing P/E n/a 21.8 management has done an excellent job of
ness equipment and billiards/bowling. Forward P/E Est. n/a 14.1 navigating the downturn. It really all
comes down to what happens with the
Share Information Largest Institutional Owners
(@2/26/10): (@12/31/09):
end consumer – even a modicum of light
Price 11.54 Company % Owned at the end of that tunnel will be great
52-Week Range 2.06 – 13.90 news for Brunswick.
Fidelity Mgmt & Research 15.0%
Dividend Yield 0.4% T. Rowe Price 7.7%
Market Cap $1.02 billion BlackRock 6.9% You mentioned smaller banks as a poten-
Financials (TTM): Dimensional Fund Adv 5.3% tial area of opportunity. Describe what
Revenue $2.78 billion Fisher Investments 5.0% you think the market is missing in Glacier
Operating Profit Margin (-14.3%) Short Interest (as of 2/12/10): Bancorp [GBCI].
Net Profit Margin (-21.1%) Shares Short/Float 16.5%
DW: Glacier is based in Kalispell,
BC PRICE HISTORY Montana, with decentralized operations
35 35
primarily in Montana, Wyoming, Utah
30 30 and Idaho. They operate separately char-
25 25 tered banks in each geographic area, with
20 20 a clear focus on each bank having a
brand, lending and deposit-taking pres-
15 15
ence that is closely tailored to the local
10 10 competitive market.
5 5 We’ve owned Glacier stock for several
0 0 years and prior to the financial crisis hit-
2008 2009 2010 ting, the company had done an excellent
job of prudently and profitably growing
THE BOTTOM LINE through selective acquisitions and by tak-
Investors have concluded that companies like Brunswick selling big-ticket consumer ing advantage of a vibrant regional econ-
discretionary items face a “two-decade secular headwind,” says Preston Athey. omy. That part of the country is one of
Assuming what he considers a moderate rebound in revenues and margins, at a 7.5x the fastest-growing regions in the United
EV/EBITDA multiple on his 2012 estimates, the shares would trade in the mid-$20s. States in terms of job creation, household
Sources: Company reports, other publicly available information
formation and personal income. As a
result, Glacier’s earnings compounded

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 5

 I N V E S T O R I N S I G H T : Preston Athey

for most of the last decade at close to turn down the government’s offer of of about 50 basis points for loan charge-
15% annually. TARP money and remains very well capi- offs, we believe the company can earn
talized. While many comparable banks between $1.50 and $1.75 per share two
How exposed has Glacier proven to be to are reporting big losses, Glacier stayed years from now.
the crisis? profitable in 2009 and the worst appears So the share price today is less than 9x
to be behind it. our 2012 earnings estimate, for a compa-
DW: They clearly haven’t been unscathed ny that has proven itself capable of grow-
by the credit problems in residential and With the stock down 6% in the past year, ing the bottom line at a mid-teens rate.
commercial real estate, but they were to a recent $14.50, the market doesn’t Given the organic growth potential in the
early in turning off credit as signs of trou- appear to be buying into that yet. region, the opportunity to steal share
ble emerged. They also never compound- from damaged competitors, and the like-
ed their problems, as many smaller banks DW: As the economy mends, we expect lihood that failing or failed banks in their
did, by getting into syndicated loans or loan demand to increase and, because markets will be available at firesale
other exotic financing beyond their fewer competitors will be in the market prices, we see no reason they can’t grow
bread-and-butter lending to local bor- lending, for Glacier’s loan spreads to at a similar rate in the future. Were that to
rowers. As a result, Glacier was able to widen. If we also assume a mid-cycle level happen, it’s not a stretch for such a bank
to trade at 15x earnings, which would
INVESTMENT SNAPSHOT result in a $24-25 share price in the next
couple of years.
Glacier Bancorp
(Nasdaq: GBCI) Valuation Metrics
(@2/26/10):
Are you concerned by the stock’s short
Business: Decentralized bank holding
GBCI Nasdaq interest, now more than 15% of the float?
company offering commercial and retail
banking services in Montana, Wyoming, Trailing P/E 25.9 18.5
Idaho, Colorado, Utah and Washington. Forward P/E Est. 13.1 16.6 DW: It’s certainly no secret that credit-
quality problems in commercial real
Share Information Largest Institutional Owners
(@2/26/10): (@12/31/09):
estate are going to hurt regional banks,
Price 14.50 Company % Owned which is why the short interest on the
52-Week Range 11.80 – 19.61 ETF tracking the KBW Regional Banking
T. Rowe Price 9.5%
Dividend Yield 3.6% BlackRock 7.1%
Index – of which Glacier is a member – is
Market Cap $893.5 million Vanguard Group 4.6% extremely high. That makes the short
Financials (TTM): Wells Capital Mgmt 3.5% interest in all the individual banks in the
Revenue $203.7 million Fisher Inv 3.4% index high as well. That doesn’t overly
Operating Profit Margin 18.6% Short Interest (as of 2/12/10): concern us – in fact, that the stock is
Net Profit Margin 16.9% Shares Short/Float 15.5% being painted with the same brush as oth-
ers when it’s objectively in much better
GBCI PRICE HISTORY shape is one reason we think it’s as attrac-
30 30
tively priced as it is.

25 25 PA: I would characterize this as a low-

risk investment. The company makes
20 20 money, has plenty of capital and is gain-
ing share in each of its markets, all of
15 15 which have attractive growth prospects.
The CEO, Michael Blodnick, is a large
shareholder himself and has always been
10 10
2008 2009 2010 disciplined in allocating capital. The
biggest risk to my mind is that the stock
THE BOTTOM LINE is dead money for a while. If 2010 is
By capitalizing on diminished competition in regional markets that retain bright growth another weak year, maybe people get
prospects, David Wagner believes the company can generate mid-teens earnings tired of it and the shares go to book
growth as the economy regains strength. Such growth would warrant a 15x multiple, he value, which is around $11 per share.
says, which on his 2012 earnings estimate would result in a share price closer to $25. Given our optimism about Glacier’s
Sources: Company reports, other publicly available information
future and our willingness to be patient,
that wouldn’t be a catastrophe.

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 6

 I N V E S T O R I N S I G H T : Preston Athey

What are you finding particularly com- excellent free cash flow. We have gotten Is the basic idea again at least a partial
pelling today about long-time holding to know the company and management return to “normal” translating into
CSS Industries [CSS]? very well, having owned the stock for healthy upside for the stock, now trading
more than 15 years. around $16.90?
PA: This company has been around for This isn’t the most economically sensi-
a long time and is primarily in the holi- tive business, but when people are cutting PA: In these small companies that few
day gifts and greetings business. They back on gift buying, dying fewer Easter people are paying attention to, that can
sell things like giftwrap, bows, ribbons, eggs, or going a bit lower-end on be all it takes.
gift cards and decorations, primarily Halloween costumes, CSS revenues do get CSS’s average revenues from fiscal
through high-volume retailers like Wal- hurt and margins suffer. Tough times also 2005 to fiscal 2009 were $515 million. So
mart or Target. They essentially create prompt their retail customers, who are let’s assume they see sales in an improving
the designs and then source the manu- always pushing them on price, to get even economy get back to $500 million over
facturing in China or wherever they find stingier. In the fiscal year that ends in the next couple of years. Their highest net
the most efficient supply, so as time has March, the company may earn as little as margin in the past five years was 5.7%,
gone on the business has become much $1.20 per share, which is down from so let’s assume that gets back at least to
less asset-intensive and now generates $2.30 two years ago. 5%. At that point the company is earning
$25 million, which is around $2.60 per
INVESTMENT SNAPSHOT share and represents a 10% return on
equity. Put an 11-12x multiple on those
CSS Industries estimated earnings and the stock would
(NYSE: CSS) Valuation Metrics
(@2/26/10):
be around $30. That wouldn’t be
Business: Producer of seasonal and spe-
CSS S&P 500 uncharted territory – the shares traded
cial-occasion “social expression” products,
including giftwrap, costumes, greeting Trailing P/E 14.0 21.8 above $40 in mid-2007.
cards, and decorative ribbons and bows. Forward P/E Est. n/a 14.1
How well protected here are you on the
Share Information Largest Institutional Owners
(@2/26/10): (@12/31/09):
downside?
Price 16.88 Company % Owned
52-Week Range 10.02 – 27.28 PA: We think we’re well protected by a
T. Rowe Price 15.3%
Dividend Yield 3.4% Royce & Assoc 11.9%
hard book value, taking out intangibles,
Market Cap $163.2 million Dimensional Fund Adv 9.3% of close to $19 per share. There’s a solid
Financials (TTM): Barclays Global Inv 4.1% dividend yield of 3.4%. We also particu-
Revenue $452.7 million Vanguard Group 4.0% larly like the company’s consistent will-
Operating Profit Margin 4.6% Short Interest (as of 2/12/10): ingness to use cash flow to buy back
Net Profit Margin 2.6% Shares Short/Float 3.5% shares when the stock is undervalued.
I’m not describing an exciting business
CSS PRICE HISTORY or a growth business. But it is a solid one
50 50
that has operated through a variety of ups
and downs. If they just continue to do
40 40 what they’ve done in the past, earnings –
and the stock price – should come back
30 30 quite nicely.

20 20 Before talking about one of the many tiny

stocks you find interesting, explain why
you bother investing in micro caps when
10 10
2008 2009 2010 you’re managing $8 billion.

THE BOTTOM LINE PA: Our view is that if we’re finding bet-
Ignoring history, says Preston Athey, the market is valuing the company’s stock as if it ter values in even the smallest companies,
won’t come out of the current poor economic cycle with its business model and prof- we should own them. If I pay the right
itability intact. If it in fact does so, as he expects, “normal” EPS within the next couple prices and own a lot of them, my down-
of years of $2.60 and an 11-12x multiple would yield a share price closer to $30. side should be limited, most of them
Sources: Company reports, other publicly available information
should earn a fair return, and every once
in a while something like K-Tron will

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 7

 I N V E S T O R I N S I G H T : Preston Athey

take off and have a real impact on the the financials, given the heavy invest- How would success impact the share
portfolio. ments they’ve made to support the new price, currently at $5.65?
strategy and the fact the onset of the
Why could IT-products distributor GTSI recession resulted in many government PA: The stock currently sells for less than
be one of those big winners? clients cutting back on IT spending. 70% of book value, which is a hard num-
We’re seeing reasonable progress in rev- ber consisting primarily of inventories
DW: The company is based just outside enues and are encouraged by what we’re and receivables. We think it’s reasonable
of Washington, D.C. and is a distributor hearing from management, which has to expect the company to grow its top
of a wide variety of technology products, been quite upfront and disciplined as it line at 8% per year – maybe 3-5% from
primarily to the government. They are a remakes the company. what government typically spends on IT
mini version of companies like CDW and Our analysis here is focused primarily and the rest from GTSI selling more
Ingram Micro, selling at an enterprise on what a reasonable margin for the busi- value-added systems. That would result
level a wide range of third-party net- ness should be in the future, and whether in close to $1 billion in revenues within
working gear, computers, software and the company is doing the right things three years. Pre-tax margins of 4% are
printers. internally in order to deliver that poten- certainly conceivable, but even at 3% that
The distribution of IT products is a tial. We believe they are. would result in a 2% net margin, or $20
low-margin affair, but we like that three
or four years ago the company decided INVESTMENT SNAPSHOT
the only way to survive in this business
was by adding engineering talent and GTSI
(Nasdaq: GTSI) Valuation Metrics
moving beyond order taking toward (@2/26/10):
Business: Reseller and integrator of infor-
more of a consultative role in defining GTSI Nasdaq
mation technology hardware, software and
technology solutions for their customers. systems, primarily for federal, state and Trailing P/E 7.6 18.5
GTSI has long-term relationships with local governmental clients. Forward P/E Est. n/a 16.6
many of its government clients, so has
Share Information Largest Institutional Owners
made progress in involving itself earlier (@2/26/10): (@12/31/09):
in the purchase process, adding value to Price 5.65 Company % Owned
it, and then still delivering systems more 52-Week Range 3.40 – 8.19 T. Rowe Price 9.9%
efficiently and at better prices than Dividend Yield 0.0% Dimensional Fund Adv 8.7%
clients could do on their own. Market Cap $54.4 million Franklin Resources 6.5%
Financials (TTM): Netols Asset Mgmt 3.7%
PA: A few years ago a government cus- Revenue $780.5 million HSBC Holdings 3.3%
tomer would have called GTSI and said, Operating Profit Margin 0.1% Short Interest (as of 2/12/10):
“What’s your best price for 100 Dell lap- Net Profit Margin 0.9% Shares Short/Float 0.1%
top computers that I plan to network
together?” The customer could expect GTSI PRICE HISTORY
15 15
nothing more. Now GTSI has answers
when the same customer says, “I’m
thinking about changing out some lap- 12 12
top computers, what technology is best
for what I need done? What kind of gear 9 9
do I need to network them? Are there
security issues I haven’t thought of?” 6 6
Starting under the Bush administration
there have been fewer internal govern- 3 3
ment resources devoted to answering 2008 2009 2010
these types of questions, so there’s an
increasing reliance on private providers THE BOTTOM LINE
like GTSI to help solve problems, rather Preston Athey believes the company’s increased emphasis on value-added selling
than just provide products. and an inevitable rebound in governmental spending on information technology can
result in 8% annual top-line growth and $2 per share in earnings within the next two
How is the strategy working so far? to three years – “which makes today’s share price look extremely cheap,” he says.

Sources: Company reports, other publicly available information

PA: It’s difficult to see the results yet in

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 8


million in net earnings. Without heroic
assumptions, that gets us to estimated
earnings per share of better than $2,
which makes today’s share price look
extremely cheap.
This isn’t a sexy story, but it’s the type
of unloved and unknown idea that we’ve
found can be very attractive. No analysts
follow the company. It has net cash on the
balance sheet. Management gets it. If the
stock just got back to the $14 level at
which it’s traded several times over the
past 15 years, we’d have an excellent
return from today’s price.
Can you generalize at all about mistakes
you’ve made?
PA: We’re from time to time reminded
that analysis can be overwhelmed by
events, and that you better have a handle
on the worst that can happen. We
thought Accuride, which is the biggest
North American manufacturer of large
truck wheels, would be well positioned
It’s time to
LOOK UP!
The Early Bird Rate
Expires 3/16/10!
Don’t miss your chance to
SAVE $1,300. Register now


t
1BTBEFOB

$" Lloyd Khaner
with discount code P10VIID!
For more information and a full list of speakers please visit www.ValueInvestingCongress.com
February 28, 2010
I N V E S T O R I N S I G H T : Preston Athey
when its market came back, a thesis that
was reinforced when a new CEO we
admired took over in the fall of 2008.
What we didn’t account for was that
Accuride’s balance sheet was too weak to
see it through the day when the market
ON PATIENCE:
If Preston is guilty of anything,
it’s of being too patient. But
patience has paid off so many
times it’s hard to be critical.
finally came back, and the company filed
for bankruptcy protection last October.
The second general category of mis-
takes I’d mention probably relates to
management. Given the importance we
often put on management’s ability to fix
problems, it’s inevitable that from time to
time we’ll fall in love too easily and make
The 5th Annual
VALUE INVESTING
CONGRESS WEST
.BZ



The Langham, Huntington Hotel & Spa
www.valueinvestorinsight.com
excuses for those in charge when the com-
pany continues to do poorly. In these
cases, my patience works against me and
we tend to ride a stock down until I get
disgusted and sell it.
DW: If Preston is guilty of anything, it is
of being too patient. But we’ve been paid
off so many times for being patient that
it’s hard to be critical. One of our largest
holdings today is Raven Industries
[RAVN], which has a rather eclectic mix
of industrial businesses. There have been
many times since we’ve owned it that you
could have said this company will never
deliver. But after some relatively minor
changes in management and strategy, it
went from a below-average business to a
well above-average one over the past four
or five years and became a star performer
for the fund.
It all comes back to what Preston said
earlier, if you pay the right price at the
right time, you can afford to wait for
good things to happen. VII
Speakers
Bruce Berkowitz
Fairholme Capital Mgmt.
Eric Sprott
Sprott Asset Mgmt.
Mohnish Pabrai
Pabrai Investment Funds
Paul Sonkin
The Hummingbird Value Funds
Thomas Russo
Gardner, Russo & Gardner
David Nierenberg
The D3 Family Funds
Khaner Capital
J. Carlo Cannell
Cannell Capital
Patrick Degorce
Thélème Partners
Whitney Tilson &
Glenn Tongue
T2 Partners
Guy Spier
Aquamarine Fund
Amitabh Singhi
Surefin Investments
...and many more!
Value Investor Insight 9

Investor Insight: Scott Hood
Scott Hood and Fred Astman of First Wilshire Securities explain where growth can be found at a discount, why inter-
national due diligence needn’t be daunting, where they never scrimp in their research, and what they think the market
is missing in Rent-A-Center, American Water Works, Imax, Jinpan International and Motorcar Parts of America.
Stocks can be cheap for a variety of rea-
sons, but what situations are most likely
to attract your attention?
Scott Hood: Our stocks tend to fall into
three broad categories. The first, where
we have the majority of our money at any
given time, is in stocks that are cheap rel-
ative to the growth potential of the com-
pany. Here I’m not talking about some-
thing with a 30 P/E and 60% potential
growth, but more like a less than 10x
multiple and 20% growth. We prefer the
companies to be in industries that are also
growing. It’s possible to find gems in
declining industries, but we’ve found that
it’s usually not wise to swim against the
current. One added benefit of the indus-
try being on the rise is that the stocks in it
are more likely to be recognized by other
investors, which can accelerate the return
on our investment.
The second general category would be
in stocks that may not be growing but are
just ridiculously cheap. They’re few and
far between, but if you’re constantly
looking as we are, you can still from time
to time find companies with P/Es in the
low single digits, trading at big discounts
to tangible book and/or with market val-
ues less than cash. These companies typi-
cally operate in mature industries that
have been overlooked by the market for a
long time. If a stock’s trading at three to
four times earnings, it doesn’t take much
incremental recognition by the invest-
ment community to make a big difference
in the share price.
The last category would be turn-
arounds. The company may have missed
earnings estimates, had a product prob-
lem of some kind or lost a key customer,
resulting in disappointed investors who
just care about near-term results and sell
the stock at a depressed price. That’s
where we’ll get interested, although we’re
unlikely to act until we see tangible signs
February 28, 2010
I N V E S T O R I N S I G H T : Scott Hood
of the turnaround or some clear positive
sentiment from the industry or manage-
ment. A few years ago, for example, we
got very interested in reinsurance compa-
nies following the big hurricanes, but did-
n’t dive in until we got early industry
feedback that rates were increasing
sharply and had studied up on hurricane
data and probabilities.
I’d add that getting turnarounds right
is very tough. It takes a tremendous
amount of research effort, the turn- Scott Hood
arounds almost always take longer than
you expect, and it’s just easy to get it Pedal to the Metal
wrong. That doesn’t scare us away, but
we’re very cognizant of the risks. Scott Hood very much enjoyed his time in
Hong Kong as a supervisory analyst for
Particularly in ideas with strong potential Merrill Lynch in the mid-1990s. He stud-
growth, why might the market miss that? ied a wide variety of industries, witnessed
first-hand the early economic transforma-
SH: Something about the company has to tion of China and took full advantage of liv-
be misunderstood. Many times it’s in an ing in one of the most dynamic cities in the
emerging industry or a growing niche world. So why move to southern California
within a mature one and the market just to become Pasadena-based First Wilshire
hasn’t caught on yet. Examples of that for
Securities' co-portfolio manager in 1998?
us over the years would have been in pay-
“To be honest, too much of the job was
day-loan companies when that business
changing 'will' to 'might' or 'would' to
was getting started, or in Asian American
'should' in analyst reports,” he says.
banks founded to serve thriving immi-
grant communities in California. We also
The move also reunited him with Fred
find opportunity in companies with slow-
Astman, who founded First Wilshire in
growing legacy businesses, but with high
1977 and for whom Hood worked prior to
growth at hand from a new product
moving to Hong Kong. Now 87, Astman
introduction, distribution channel or
still manages the portfolio jointly with
emerging market. In small caps, those
Hood, who offers his investment mentor
types of things can make a big difference,
high praise: “Fred combines two very
but may be obscured if the bigger tradi-
important qualities in an investor. On the
tional business isn’t so hot at the moment.
one hand, he's a rock in terms of sticking
We also find that geography makes a
with his discipline and strategy regardless
difference. The further a company is from
of how bleak things may be at the time,”
New York, Boston, Chicago, L.A. and
Hood says. “At the same time, he's incred-
San Francisco, the less attention – and
often less respect – they get. In the 1990s, ibly open to new businesses, new indus-
we started finding a lot of companies in tries and new markets and is constantly
the upper Midwest that weren’t well-fol- pushing us to figure out where the oppor-
lowed but had smart, entrepreneurial tunities are. We sometimes joke that he's
managers who were building great busi- the gas pedal and I'm the brakes.”
www.valueinvestorinsight.com Value Investor Insight 10

nesses. Minnesota is still probably our
favorite state for stock ideas.
This out-of-sight, out-of-mind dynam-
ic now applies to companies overseas.
Over the past ten years we’ve found a
great number of opportunities in small
U.S.-listed companies that operate almost
exclusively outside the U.S., particularly
in China. It’s rare for someone to visit a
$100 million market-cap company that’s
15 hours away, which can result in com-
panies with 15% growth trading at 5
P/Es. We’ve been going to China, for
example, for more than ten years and
always have a list of companies to visit
that look incredibly cheap on paper. We
think being there allows us to better dis-
tinguish those that deserve to be cheap
from those that don’t.
How much of your portfolio today is in
international companies?
SH: It’s usually 20-25%. In addition to
finding great valuations, we also like the
geographic and currency diversification.
You could argue that with more than
30% or so of your portfolio outside the
U.S., you may be starting to make curren-
cy bets and adding risk to the portfolio,
but we think our level of exposure is in
the sweet spot where it improves our
diversification and return potential. Still,
that’s just an added kicker – we buy these
stocks because they offer good value and
return potential regardless of where they
are located.
You pride yourself on your level of due
diligence. Isn’t that much tougher outside
the U.S.?
SH: It can be, but we tend to stick with
companies that list in the U.S. and so
have to meet all the standards for finan-
cial disclosure and communication that
entails. We also don’t scrimp on doing the
same types of site visits, channel checks
and industry research we do in the U.S. In
fact, I’d argue that our experience in
places like China has made us even more
diligent about digging for information in
the U.S. You don’t take anything for
granted in China – we shouldn’t do that
here either.
February 28, 2010
Whether we’re investing international-
ly or not, we look for companies with
long operating histories, that have suc-
cessfully been through a variety of cycles
and that have stable management. They
have well-respected auditors and take the
investor-relations function seriously. That
all makes due diligence somewhat easier.
I’ll give you a couple examples of the
types of companies we own in China.
Chindex International [CHDX] owns and
operates Chinese hospitals and clinics and
also sells medical capital equipment.
We’ve owned the stock for years and
think it’s one of the blue-chip U.S.-listed
companies, with a great management
team, great relationships with the govern-
ON RESEARCH:
We’re big believers in the
Peter Lynch quote, that “the
person who turns over the
most rocks wins the game.”
ment and a leading franchise in a boom-
ing market. The company today isn’t ter-
ribly cheap on earnings – 16x trailing 12-
month EPS – but we believe that’s more a
function of heavy spending on building
new hospitals and a cyclical dip in equip-
ment sales masking the earnings power
that should come out of there. If you
want to participate in healthcare in
China, there’s probably no better way.
Another company we’re high on is
Harbin Electric [HRBN], which makes
direct-drive motors used in things like
subway trains, car seats, postal sorting
machines and even meat slicers. The mar-
ket can get overexcited and then com-
pletely abandon the stock, but the compa-
ny grows fairly steadily and the CEO is a
fanatic about product improvement and
building the company. There’s a tremen-
dous emphasis in China on engineering
and product development. Companies
like Harbin can have 50 engineers for
every one at a comparable U.S. company,
and they’re all focused on making even
obscure parts or processes better. Like
Chindex, it’s a high-quality company. We
www.valueinvestorinsight.com
I N V E S T O R I N S I G H T : Scott Hood
don’t find the research into these types of
companies any harder than it would be
here, though the opportunity to find a
good company at a low price is greater.
Turning to your research process, how do
you generate ideas?
SH: It’s almost always triggered by valu-
ation. Rarely will we get into a new stock
unless it has a trailing earnings multiple
below 10x or hidden earnings power that
makes it below 10x in the near future.
One screen we perform every day goes
through companies that announce quar-
terly earnings, which we annualize to cal-
culate P/Es. We’ll then go through the
lowest P/Es on the list and after a very
cursory look will pick out those we think
deserve a closer review.
For those stocks we’ll produce what
we call a quick-take report, which
answers the core 17 questions we want to
know about each company. It’s pretty
standard stuff to get a quick and consis-
tent read on earnings quality, the balance
sheet, management and the competitive
environment. From that, Fred or I will
make the call whether to do a full report.
The research from here on is where we
try to distinguish ourselves. We’re big
believers in that Peter Lynch quote, that
“the person who turns over the most
rocks wins the game.” We always say that
people who know what they’re doing can
get 80% of the story in no time, just by
looking through the financials. But it’s
that last 20% that requires tremendous
effort and that is going to set you apart,
or not. That’s the detective work, the site
visits, the channel checks, the background
checks, the legal research – all the things
that may or may not give you unique
insight, but which you have to do well to
get any kind of edge.
Are there particular areas you emphasize
in your research?
SH: In the old days, with small companies
analysts could practically send their earn-
ings model to the CFO and he'd correct it
and send it back. With information more
tightly controlled, that's put the burden
back on analysts to really do their work.
Value Investor Insight 11

Our goal is to understand companies
and their businesses in the same way the
managers and employees do. You can’t
do that without being out in the industry
talking to suppliers, customers and com-
petitors, without spending a lot of time
with management, without visiting facil-
ities. We encourage our analysts to be
creative and want included in every full
report a description of what he or she
did that was different in looking at the
company. One of our analysts recently
visited the properties behind the 20
largest loans made by a bank we were
researching, canvassing the neighbor-
hood, speaking with tenants, taking
photos. Those types of things greatly
improve the quality of the discussion
you can have with a company.
We won’t buy into any company
unless Fred or I have personally spent
time with the management. It’s certainly
not an exact science, but we want to be
convinced the people running the compa-
ny are knowledgeable, capable, trustwor-
thy and energetic. If times are tough we
want them to be upfront about it, and if
times are good we want them to always
be looking around the next corner for
trouble. We believe getting to know man-
agement over time builds a rapport that
allows us to pick up subtle clues about
the company’s prospects that others are
likely to miss.
I’m still amazed by the things you’ll
hear or see on a company visit. We visit-
ed one company in Florida that made
simulators for pilot training and amuse-
ment rides and heard all about the long
lead time between the start of contract
negotiations and product delivery, includ-
ing nine months or so for manufacturing.
Later on in the day we toured the manu-
facturing facility and of the 12 assembly
bays, only two had anything going on.
That wasn’t a big endorsement of the
company’s prospects.
We’ve built a database over the past 15
years in which we keep all the company
research we’ve done. We type up notes
from every conversation, include photos
of company visits, and include all of our
models. It’s a great complement to the
knowledge we try to carry around in our
February 28, 2010
heads, and allows anyone at the firm to
get up to speed quickly on any company
in our universe.
We’re assuming your research process
itself produces adjacent ideas from time
to time.
SH: Absolutely. In one recent example, in
doing research on American Water
Works, which we’ll speak about later, we
did a screen to find the cheapest water
ON SELLING:
We get concerned when com-
panies veer from what they do
well. When cash flow is divert-
ed elsewhere, so are we.
utilities in the world. What came up was
Companhia de Saneamento Basico do
Estado de Sao Paulo [SBS], the water util-
ity in Sao Paolo, Brazil which happens to
be listed in the U.S. In looking into it, we
were very impressed with management
and liked the exposure to the city, the
country and the currency. But we really
liked the 6x P/E and the 6% yield, which
is still around where it trades today.
What’s a typical position size for you
when you’re ready to buy?
SH: There are certain situations in which
we might work our way into a position,
say a turnaround in which we want more
time and experience with the company
before deciding to fully step in. But in
general, our initial position sizes for core
positions are from 2-5%. We’ll have
between 15 and 20 of those core positions
at any given time, with the rest of the
portfolio in ideas that are either in the
incubation phase or have to be kept small
because the market caps are so tiny.
Do you have any strict rules on selling?
SH: For ideas that have worked out, val-
uation is usually the primary driver. We
www.valueinvestorinsight.com
I N V E S T O R I N S I G H T : Scott Hood
don’t follow strict rules, but just as some-
thing trading below 10x is a buy, some-
thing over 20x on a forward basis is typ-
ically a sell.
In between, it depends what’s going on
with the company. We’ve found that if we
really understand a company and have a
high level of confidence in its earnings
over the next three or four quarters,
there’s no rush to sell unless the market’s
expectations outstrip ours.
We get concerned when companies
start veering from what they do well. If
they start diverting cash flow to acquisi-
tions in new areas or on major capital
spending for a product diversification,
there’s a good chance we won’t be in the
position much longer.
We’re curious how you’ve handled your
position in Atlantic Tele-Network
[ATNI], which went from $14 to $53
between March and September of last
year, making it your biggest position at
the end of the third quarter.
SH: This is an interesting case – we
haven’t sold because the earnings multi-
ple is probably lower than it was a year
ago, even though the stock has taken off.
The company’s legacy asset had been the
primary telephone operator in the coun-
try of Guyana, on the northern coast of
South America. By putting itself in the
right place at the right time, last year
ATNI bought wireless assets serving
800,000 rural customers primarily in the
southern U.S., which Verizon had to sell
to get regulatory approval for its pur-
chase of Alltel.
ATNI paid about $250 per subscriber,
one-sixth what AT&T paid for compara-
ble assets from Verizon and one-eighth
what Verizon paid for the subscribers in
the first place. The end result is that the
company has added nearly $4 per share in
earnings power going forward. They have
to execute, but we’re optimistic about
their prospects and still find the valuation
quite compelling.
Turning to some specific ideas, explain
the investment thesis behind Rent-A-
Center [RCII]?
Value Investor Insight 12
 I N V E S T O R I N S I G H T : Scott Hood

SH: This is the largest rent-to-own retail- they can return it whenever they want been in this business for decades, serving
er, ahead of Aaron’s, with around 3,200 without any more payments. these types of customers, and now they
stores in the U.S. and Canada and a prod- We’ve actually become a customer so don’t have to compete as much with the
uct mix that includes a variety of big-tick- we can go through the process, including easy-credit folks. The countervailing fac-
et items like furniture, flat-panel TVs and varying our payments to see how they tor, of course, is the lousy economy and
appliances. Their typical customer is respond. It’s quite impressive how uni- high unemployment, but we’d argue
someone with a job, but who doesn’t form and consistent the response is those things should improve before the
have the savings or can’t get the financing regardless of the store or region. They’ll era of easy credit returns.
to purchase outright, say, a full bedroom call and know your situation and are very
set or a flat-panel TV. By renting from persistent in making sure everything is on Who is the typical customer?
Rent-A-Center they can have the mer- track. If it’s not, they’ll come around to
chandise now, paying something on the pick up the merchandise. That level of SH: They’re working, have below-aver-
order of $32 per week in rent over a 24- responsiveness allows them to never let age household income and little or no real
month period for merchandise that might non-payment problems get out of control. banking relationship. That probably
cost $1,600 at retail. If they pay through This era of tight credit should be a real describes 20-25% of the working popula-
the end of the term, it’s theirs to keep, but positive for Rent-A-Center. They have tion in the U.S. Customers fill out a fairly
quick application, which requires land-
INVESTMENT SNAPSHOT lord, employer and personal references,
used in the approval process and to fol-
Rent-A-Center low up with at any sign of a late payment.
(Nasdaq: RCII) Valuation Metrics
(@2/26/10):
The business is somewhat cyclical, but
Business: Owns and franchises stores
RCII Nasdaq the swings are moderated by the fact that
that offer big-ticket durable goods – such
as consumer electronics, appliances and Trailing P/E 8.8 18.5 in good times more people have jobs and
furniture – under rent-to-own agreements. Forward P/E Est. 8.3 16.6 move into the company’s demographic,
while in tough times people who before
Share Information Largest Institutional Owners
(@2/26/10): (@12/31/09):
might have bought outright start to find
Price 22.24 Company % Owned Rent-A-Center’s type of affordable pay-
52-Week Range 16.25 – 23.14 ment schedule a better option. Same-store
BlackRock 9.4%
Dividend Yield 0.0% Hotchkis & Wiley 6.7%
sales declined somewhat in 2009, but
Market Cap $1.46 billion Vanguard Group 4.5% they’re expected to increase 1% or so in
Financials (TTM): Robeco Inv Mgmt 4.4% 2010. Because the company has aggres-
Revenue $2.75 billion Artisan Partners 4.4% sively cut expenses – closing some previ-
Operating Profit Margin 10.6% Short Interest (as of 2/12/10): ously acquired redundant stores and cut-
Net Profit Margin 6.1% Shares Short/Float 6.1% ting store-level labor and inventory costs
– EPS actually grew 20% last year.
RCII PRICE HISTORY
35 35
How cheap are the shares, now trading
30 30
around $22.20?

25 25 Frederick Astman: The company earned

just over $2.50 per share last year and is
20 20 expected to earn about the same this year.
That results in a P/E of less than 9x. Even
15 15
with no same-store sales growth, we
10 10
believe they’ll continue to reduce costs
2008 2009 2010 and earn around $2.70 per share in 2011.

THE BOTTOM LINE The company hasn’t always had the most
The company’s rent-to-own business is well positioned to benefit as target customers pristine balance sheet. Is that an issue?
find credit financing tight and seek out more affordable payment schedules for big-
ticket items, says Scott Hood. At the mid-point of their historical P/E range on his FA: They’ve actually been paying down
2011 earnings estimate, the shares a year from now would trade at close to $30. debt, reducing long-term debt by over
Sources: Company reports, other publicly available information
$230 million last year. The company
should have free cash flow of $160 mil-

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 13

 I N V E S T O R I N S I G H T : Scott Hood

lion in 2010 to pay down more debt or
buy back stock.
Today’s P/E is in the lower end of its
historical range, which has pretty consis-
tently been between 7x and 15x. If they
just keep plugging along while continu-
ing to pay down debt, there’s no reason
the stock shouldn’t trade at 11-12x
expected earnings a year from now,
which would result in a share price of
close to $30. If we’re right and the com-
pany starts growing again as the econo-
my recovers and the lack of credit avail-
ability drives customers their way, that
also should be quite a catalyst for the
stock on top of that.
catch-up increases that will allow it to
approach the typical 10% returns on
invested capital other utilities get. That
issue alone gives American Water a high-
er growth profile over the next few years
than most of their peers.
What’s appealing in general about the
water-utility business?
SH: There’s a great deal of emphasis by
many municipalities on improving water
quality, and environmentally and eco-
nomically, clean tap water is a much bet-
ter alternative to water in plastic bottles,
which are shipped hundreds or thousands
of miles and then discarded or recycled.
There’s also no comparison on cost –
maybe only a penny for every two gallons
of clean tap water, which is transported
by infrastructure that’s already in place.
An important catalyst may come from
the federal government: the EPA estimates
that for its standards on clean drinking
water to be met, hundreds of billions of
dollars in capital spending is necessary to
upgrade and add water-related facilities in
the U.S. That’s a growth opportunity for
American Water – it plans to invest $5 bil-
lion in new facilities over the next five
years, on which it expects to generate
roughly 10% returns going forward.

You mentioned water utilities earlier, INVESTMENT SNAPSHOT

what attracts you to American Water
Works [AWK]? American Water Works
(NYSE: AWK) Valuation Metrics
Business: Founded in 1886, largest (@2/26/10):
SH: American Water Works is the largest AWK S&P 500
provider of water and wastewater services
water and wastewater-treatment utility in to residential, commercial and industrial Trailing P/E n/a 21.8
the U.S., operating in more than 30 U.S. customers in the United States. Forward P/E Est. 15.5 14.1
states but with roughly half its business in
Share Information Largest Institutional Owners
Pennsylvania and New Jersey. The origins (@2/26/10): (@12/31/09):
of the company go back to 1886 and it Price 22.26 Company % Owned
first went public more than 60 years ago, 52-Week Range 16.22 – 23.77 JPMorgan Chase 6.0%
but it was taken private by the German Dividend Yield 3.8% Capital Guardian Trust 3.8%
utility company RWE in 2003. It came Market Cap $3.89 billion Pictet Asset Mgmt 3.5%
back public again in 2008 when RWE Financials (TTM): Vanguard Group 3.1%
decided it didn’t want to be in this busi- Revenue $2.41 billion Capital World Inv 2.9%
ness in the U.S. Operating Profit Margin 25.5% Short Interest (as of 2/12/10):
A big problem for the stock has been Net Profit Margin (-9.7%) Shares Short/Float n/a
that RWE, to get regulatory approval for
the acquisition, agreed to not ask for rate AWK PRICE HISTORY
25 25
increases for up to five years even though
it was spending a lot of money on capital
projects. So you have a company that
came public in a bad market, with the
overhang of a big shareholder looking to 20 20
unload shares, and with lousy numbers
because of goodwill writeoffs and histor-
ical rate restrictions. All that is what cre-
ated the opportunity in the first place.
15 15
2008 2009 2010
How are those issues working out?
THE BOTTOM LINE
SH: RWE is now completely out, so the Industry growth from needed spending on water-related infrastructure and company-
overhang issue should be gone. The good- specific growth from catch-up rate increases should fuel 10% annual earnings
will writeoffs should be over. On the rate growth over the next five years, says Scott Hood. At a peer multiple on his 2011 EPS
issue, it will probably be two to three estimate of around $1.65, the shares would trade in the low-$30s a year from now.
years before all the original agreements Sources: Company reports, other publicly available information
expire and the company is able to get

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 14

 I N V E S T O R I N S I G H T : Scott Hood

Another tailwind is that so many states lower the upfront cost to theater owners revenues come from Imax screens,
and municipalities are having budget of their high-end systems, while taking a although those screens make up only 2%
problems that we’re likely to see an bigger cut of the ongoing net profits from of the total. A multiplex showing a movie
increase in their willingness to sell their the Imax-equipped theater. like Avatar or The Dark Knight on three
water-utility operations off to companies No transition like this is entirely screens, one of which is Imax, will sell out
like American Water. Roughly three-quar- smooth, but Imax is now hitting its stride. the Imax showing before they fill out the
ters of all utilities are government-owned, It finally started generating earnings in other theaters – and people will pay a pre-
and while turning the operation of them the second quarter of last year and the mium to see it in Imax. This is not just a
over to private interests is politically diffi- sales backlog for new systems – about U.S. phenomenon – we sent people to
cult, it’s often the best economic solution. 170 screens and growing – remains very check out Imax showings of Avatar in
strong. They put in more than 80 new China and they came back saying there
With American Water shares just above systems last year, bringing the total were lines to purchase tickets stretching
$22, how are you looking at valuation? installed base to over 400. for blocks. Given that Imax is on only
Consumer enthusiasm for the technol- eight screens in China today – with
SH: We’re expecting $1.50 per share in ogy is proven and keeps getting better. another 22 on order – the growth poten-
earnings this year, and just from organic For a movie shown in Imax, 10% of gross tial there is enormous.
growth and the catch-up in rates we think
that can grow at least 10% annually for INVESTMENT SNAPSHOT
the next five years. But at 15x estimated
2010 earnings, American Water’s shares Imax
(Nasdaq: IMAX) Valuation Metrics
trade at a significant discount to its peers, (@2/26/10):
Business: Design, manufacture, sale and
which trade at around 20x. Given that IMAX Nasdaq
lease of digital and film-based theater sys-
they have better growth prospects and a tems used in the presentation of large-for- Trailing P/E n/a 18.5
decent balance sheet, that discount makes mat 2-D and 3-D motion pictures. Forward P/E Est. 22.7 16.6
no sense to us. Just by matching the peer
Share Information Largest Institutional Owners
multiple, we’d expect the stock to be trad- (@2/26/10): (@12/31/09):
ing at least in the low $30s over the next Price 13.41 Company % Owned
year or so. 52-Week Range 3.74 – 14.60 Tremblant Capital 7.1%
The dividend is also nice here, with a Dividend Yield 0.0% Gilder Gagnon Howe & Co 5.3%
current yield of 3.8%. We expect them Market Cap $835.5 million William Blair & Co 5.0%
to increase it further this year, and Financials (TTM): First Wilshire Securities 4.5%
wouldn’t be surprised if the annual divi- Revenue $145.3 million Manatuck Hill Partners 4.2%
dend run rate was closer to 95 cents by Operating Profit Margin 4.1% Short Interest (as of 2/12/10):
the end of 2010. Net Profit Margin (-5.5%) Shares Short/Float 20.0%

The shares of your next idea, Imax IMAX PRICE HISTORY

15 15
[IMAX], have been on a bit of a tear.
Why are you still bullish? 12 12

SH: Imax has been around for more than 9 9

40 years, with a name everybody knows
worldwide even though they’ve spent
very little on promoting it. After focusing
for much of its history on niche markets
like museums for their movie-projection
technology, in the past few years the com-
pany has focused on broadening its the-
ater base in two primary ways. First, they
developed a more cost-effective digital
projection system, looking to tap what
over time will be a significant turnover at
theaters from reel-based projection to
digital. At the same time, they’ve recast
their business model to significantly
6 6
3 3
0 0
2008 2009 2010
THE BOTTOM LINE
Scott Hood doesn’t believe the market fully recognizes the strength of the company’s
brand and the earnings power of its newly evolved business model. If he’s right that
the company will earn well over $1 per share a couple years out and can grow beyond
that at 20-30% annually, he expects today’s share price to prove quite inexpensive.
Sources: Company reports, other publicly available information

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 15

 I N V E S T O R I N S I G H T : Scott Hood

Given the rapid increase in the stock price, For every risk, we also see plenty of are mostly used in institutional settings
to a recent $13.40, isn’t the story out? other opportunities. With systems going such as large buildings, subway systems,
digital, Imax could potentially extend its factories and airports, and while they can
SH: We still don’t think the market under- brand to showing live events like the be more expensive than the typical oil-
stands the power of the business model. Super Bowl. It also recently announced a filled transformer used in the U.S., they
Because Imax is adding screens at a rapid venture with Disney and Discovery to are also less flammable, more energy-effi-
pace, the impact of the back-end revenue develop a 3-D television station. We think cient and require less maintenance.
they get from ticket sales and concessions the brand has a lot of room to run. We discovered Jinpan ten years ago
hasn’t fully worked itself into the finan- and it’s done an excellent job since in cap-
cials. We expect first-quarter numbers, Talk about one of your favorite U.S.-list- italizing on the dramatic development of
partly reflecting the huge success of ed Chinese companies, Jinpan Chinese industry and infrastructure.
Avatar, to surprise on the upside. We also International [JST]. Management has proven to be both excel-
think the consensus 58-cent estimate for lent operators and builders of long-term
2010 earnings per share will turn out to SH: Jinpan designs and manufactures shareholder wealth. They spend heavily
be conservative. large cast-resin transformers used in the on R&D and have nearly 100 engineers
distribution of electricity. Its transformers on staff (out of 700 or so employees) who
FA: Over the next five years we believe
the number of screens can grow by 10- INVESTMENT SNAPSHOT
20% per year, while earnings may grow
closer to 20-30% per year. Their eventual Jinpan International
(Nasdaq: JST) Valuation Metrics
target is for up to 1,000 screens globally. (@2/26/10):
Business: Based in Hainan, China,
If we’re right, the company a couple JST Nasdaq
designs, manufactures and distributes cast
years out is earning well over $1 per resin transformers used in high-voltage Trailing P/E 12.2 18.5
share. What kind of multiple does some- electricity distribution equipment. Forward P/E Est. 12.5 16.6
thing growing that fast deserve? We don’t
Share Information Largest Institutional Owners
spend much time speculating on that type (@2/26/10): (@12/31/09):
of thing, but we can imagine it will be Price 22.18 Company % Owned
high enough to make today’s share price 52-Week Range 5.67 – 26.44 First Wilshire Securities 4.0%
look quite cheap. Dividend Yield 0.5% Royce & Assoc 2.4%
Market Cap $355.9 million Wells Fargo & Co 2.0%
What are the biggest risks? Financials (TTM): Albion Financial 2.0%
Revenue $167.2 million Munder Capital 1.2%
SH: There’s always the risk that a new Operating Profit Margin 18.9% Short Interest (as of 2/12/10):
technology comes along to make Imax Net Profit Margin 17.7% Shares Short/Float n/a
seem less special, but given how truly
superior the Imax viewing experience is JST PRICE HISTORY
30 30
today, we think that risk is fairly low.
There’s some risk, especially as Imax 25 25
becomes more dependent on ticket sales
and concessions, that it will get whip- 20 20
sawed by Hollywood’s hits and misses.
Given the strong growth in the installed 15 15
base, we don’t at all need each movie to
10 10
be an Avatar to get the type of growth
we’re expecting. Also, with digital sys- 5 5
tems it’s easy to switch out of a movie 2008 2009 2010
that isn’t working to one that will.
There is some concern that the revenue THE BOTTOM LINE
share with studios and the new joint-ven- The company’s shares trade as if its growth prospects are moderate, but that’s not the
ture business model with theater owners case, says Scott Hood. Expanded capacity to meet ongoing growth in Chinese power-
will prove to be too good and Imax will related infrastructure can help generate 20%-plus earnings growth over the next five
have to renegotiate terms. In the grand years, he says. At 18-20x his 2011 EPS estimate, the shares would trade closer to $40.
scheme of things, it’s hard for us to see Sources: Company reports, other publicly available information
that as a big problem.

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 16

 I N V E S T O R I N S I G H T : Scott Hood

constantly focus on upgrading the com- great deal of potential beyond that. Their tomers. We found it years ago when it
pany’s products to compete against state- transformers have been UL-certified in was having accounting problems and
owned and private competitors in China. the U.S., which opens a big opportunity going through a painful process of chang-
Revenues have quadrupled over the past for them here over time. They also have ing management, changing auditors and
five years, to $160 million in 2009. significant potential in new end-user mar- trying to get back into the good graces of
Our basic view is that while the shares kets, like General Electric’s use of their the investment community.
trade as if growth prospects are moder- transformers in wind-power generators. Through all that, the underlying busi-
ate, that’s not at all the case. The infra- We expect them to be extremely competi- ness proved quite simple and resilient.
structure needs in China to support the tive in whatever markets they choose to After five to seven years, alternators and
economy’s growth remain enormous. To pursue. starters in your car are likely to wear out.
get its fair share of that, Jinpan has a sig- You can replace them with new ones or,
nificant amount of new capacity coming Tell us about a micro-cap idea, Motorcar for less money, with those that have been
fully on line this year, adding a newly Parts of America [MPAA]. remanufactured by MPAA or one of its
built plant in Wuhan and an acquired one competitors. MPAA is the leader in its
in Shanghai to its existing facility in SH: The company remanufactures vehicle market, with an excellent reputation for
Hainan. From China alone, we expect the alternators and starters for U.S. cus- quality and reliability.
company over the next five years to gen-
erate 20% top-line growth and a few INVESTMENT SNAPSHOT
points better than that on the bottom line.
Motorcar Parts of America
(Nasdaq: MPAA) Valuation Metrics
How inexpensive do you consider the (@2/26/10):
Business: Remanufacturer of car and
shares, at a recent $22.20? MPAA Nasdaq
truck alternators and starters, sold to auto-
motive retail outlets and the professional- Trailing P/E 11.5 18.5
SH: The stock trades today at less than repair market in the U.S. and Canada. Forward P/E Est. 7.1 16.6
13x estimated 2010 EPS of $1.70. You
Share Information Largest Institutional Owners
won’t find many U.S. companies capable (@2/26/10): (@12/31/09):
of growing earnings at 20-25% a year Price 5.30 Company % Owned
trading at that kind of multiple. 52-Week Range 3.05 – 5.93 Rutabaga Capital 9.2%
We think one issue is that Jinpan gets Dividend Yield 0.0% Wellington Mgmt 6.4%
lumped in with newer Chinese companies Market Cap $63.7 million Janus Capital 5.4%
listed in the U.S. that just aren’t of the Financials (TTM): First Wilshire Securities 4.9%
same quality. It’s a proven company with Revenue $138.5 million Keane Capital 4.7%
a long track record through various Operating Profit Margin 9.5% Short Interest (as of 2/12/10):
cycles. While there’s always going to be Net Profit Margin 4.0% Shares Short/Float n/a
some additional risk because it’s in China,
trading at a P/E that is half the expected MPAA PRICE HISTORY
15 15
growth rate strikes us as far too large a
discount. That’s especially true given the
strength of the balance sheet, which cur- 12 12
rently has more cash than debt. They even
pay a small dividend, which is rare for 9 9
fast-growing Chinese companies.
A year from now the market will be 6 6
looking toward a 2011 in which we
believe Jinpan can earn $2.10 to $2.20
3 3
per share. If the growth profile is what we 2008 2009 2010
expect, there’s no reason that shouldn’t
warrant at least an 18-20x multiple. THE BOTTOM LINE
The company’s business is simple and resilient, says Scott Hood, evidenced by the
Does the company have aspirations out- fact he expects its earnings in the fiscal year ending in March to double. But on his
side of China? 2011 estimates, the shares today trade at less than 6x earnings and only 5x free
cash flow. What’s the market missing? “We can’t figure that out,” he says.
SH: They’ve been smart to stay primarily Sources: Company reports, other publicly available information
focused on their home market, but have a

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 17


The business is relatively stable, with
revenues tied to overall miles driven and
the age of cars in the country. Right now
overall miles driven are down, but people
cutting back on new-car purchases is a
positive for MPAA and will likely contin-
ue to be as the car population ages. The
bottom line is driven by how efficiently it
turns out high-quality parts at its facilities
in Mexico and Malaysia. It’s hard to
make profitability comparisons because
most competitors are private, but MPAA
in normal times generates operating mar-
gins in the 6-10% range.
How are earnings holding up?
SH: The company earned 32 cents per
share in the fiscal year ending in March
2009 and should earn close to 65 cents in
the year ending next month. Free cash
flow on a per-share basis in fiscal 2010
should be around 80 cents. So the shares
[at a recent $5.30] trade at 8x estimated
earnings and 6.5x free cash flow. On our
2011 estimates of 90 cents in EPS and
What are the world’s best investors
buying and selling?
Gain insight from what superstar investors
own, what they’re buying and what
they’re selling. Value Investor Insight
subscribers receive four quarterly issues
of SuperInvestor Insight for only $149!
Subscribe Online »
Mail-in Form » Or call toll-free:
866-988-9060
Fax-in Form »
Want to learn more?
Please visit www.valueinvestorinsight.com
February 28, 2010
$1.05 in free cash flow, they’re that much
cheaper.
What’s the market missing?
SH: We can’t figure that out. The compa-
ny’s earnings and cash flow have never
ON CHINESE STUDENTS:
Were they well-versed in pri-
vate enterprise? I could have
been with the Republican Club
at the University of Texas.
been better and the balance sheet is per-
fectly fine, but the stock is roughly one-
third its level of three years ago. There’s
always a chance they’ll lose a contract, or
customers will push them on margins, or
bad weather will temporarily cause miles
driven to fall off, but things on those
fronts aren’t much different today than
NEW ISSUE just published on
February 23 – DON’T MISS IT!
www.valueinvestorinsight.com
I N V E S T O R I N S I G H T : Scott Hood
they have been. If the issue is just that no
one is paying attention, we’d expect that
to at least partly change as the company
confirms good earnings numbers.
Scott, you recently presented a value-
investing seminar in China. Any stories to
tell from that?
SH: We were at one of the top universi-
ties and drew a good crowd, which sur-
prised me a bit because the focus for
investors there is so much about growth –
they’re generally not afraid of high P/Es.
Our talking about finding opportunity at
times in marginal companies that are just
very cheap was a concept very different
from the current mindset.
But in terms of whether they were
well-versed in private enterprise and cap-
italism, I could have been speaking to the
Republican Club at the University of
Texas. If there’s anyone left who doesn’t
think the Chinese understand how to
compete in a global economy, they’re
obviously not paying attention. VII
Value Investor Insight 18
 U N C O V E R I N G V A L U E : Kraft

Food for Thought

Acquiring-company managers typically tout the “transformational” nature of big deals while Wall Street looks
on with skepticism. In the case of Kraft buying Cadbury, Bill Ackman expects the skeptics to be dead wrong.

There was no shortage of good theater investments pay off, Ackman expects Kraft has been on a similar long-lived
in Kraft Foods' recent takeover battle for Cadbury's EBIT margins to rise to the campaign to improve its own peer-lagging
Cadbury PLC. Included in the drama mid-to-high teens, from 13.5% today. operating margins, which fell from 21%
were nasty top-executive barbs, hand- “Often in branded-foods acquisitions in 2002 to 12.8% in 2008 due to a vari-
wringing over matters of national pride, the acquirer ends up buying a portfolio of ety of product and marketing missteps, a
rumored third-party bids, and even some brands that has been starved of marketing need for catch-up R&D spending, and
well-chosen cautionary words from support and capital investment,” says commodity-cost woes. Ackman credits
Kraft's largest shareholder, Warren Pershing Square partner Ali Namvar. management with improving the quali-
Buffett. In the end, Kraft clinched the deal “This is not at all the case with Cadbury.” ty/value propositions for many of Kraft's
on January 19th with a sweetened $19.4
billion bid, bringing the curtain down on INVESTMENT SNAPSHOT
Cadbury's nearly 200 years as an inde-
pendent company. Kraft Foods
(NYSE: KFT) Valuation Metrics
Wall's Street's reaction to Kraft's bold
Business: Global manufacturer and mar- (@2/26/10):
acquisition stroke? An extended yawn.
keter of branded snacks, packaged foods KFT S&P 500
On the day before Kraft launched its first Trailing P/E 14.0 21.8
and (increasingly after agreement to buy
bid last September, Kraft shares closed at Cadbury) confectionary products. Forward P/E Est. 12.2 14.1
$28.10. Since then they've waffled
Share Information Largest Institutional Owners
between $26 and $30, closing most (@2/26/10): (@12/31/09):
recently at $28.40. Zzzzzz. Price 28.43 Company % Owned
Count Pershing Square Capital's Bill 52-Week Range 20.81 – 30.10 Berkshire Hathaway 9.4%
Ackman as one prominent investor who Dividend Yield 4.0% State Street Corp 5.0%
finds the market's torpor to be misplaced. Market Cap $42.02 billion Barclays Global Inv 4.9%
He expects the combination to accelerate Financials (TTM): Capital Research Global Inv 4.0%
already-in-place initiatives to improve Capital World Inv 4.0%
Revenue $40.39 billion
margins and to significantly enhance each Operating Profit Margin 13.8% Short Interest (as of 2/12/10):
company's standalone organic growth Net Profit Margin 7.5% Shares Short/Float 3.6%
prospects. “The candy business is one of
the great businesses in the world,” he KFT PRICE HISTORY
40 40
says. “I hesitate to call any acquisition a
steal, but this deal should ultimately
prove to have been done at a very favor- 35 35
able price.”
Key to his optimism is the fact that 30 30
Cadbury was doing many of the right
things to improve its profitability and the 25 25
strength of its brands – which include
Cadbury confectionary products, Halls
20 20
cough drops, and Dentyne and Trident 2008 2009 2010
gums – the results of which will now
accrue to Kraft. Cadbury has invested THE BOTTOM LINE
heavily in emerging-market distribution, The market is underestimating both the independent progress Kraft and Cadbury have
where it now earns more than 40% of its made in improving profitability as well as the revenue and cost benefits to accrue from
sales. It has in recent years increased their combination, says Bill Ackman. With the dividend and even a 15x multiple on his
spending on marketing and R&D, while 2012 earnings estimate, the shares would return 50-60% over the next two years.
also building new plants now coming on
Sources: Company reports, other publicly available information
line in low-labor-cost countries. As those

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight 19


products, weeding out weak brands and
improving supply-chain efficiencies, and
he expects EBIT margins to improve to
15% by 2011. That level shouldn't be the
ultimate goal, he says, as other U.S.
branded-food companies like General
Mills, J.M. Smucker and Campbell Soup
consistently earn margins above 17%.
Beyond the increased profit potential
of each company on its own, Ackman is
also enthusiastic about incremental
upside from combining the companies'
efforts. The new Kraft will earn 50% of
its revenues from branded candy, cookies
and snacks, categories in which store
brands have found it difficult to make
inroads, and which are particularly well-
suited to take advantage of developing-
country growth. Each company's distri-
bution strengths – Kraft in direct-to-store
distribution in North America and
Cadbury in emerging markets and in
“instant-consumption” channels like con-
venience stores and gas stations – should
benefit the other company's products.
While he believes the old Kraft was capa-
ble of 3% to 3.5% annual organic rev-
enue growth, Ackman thinks the new one
Looking for investment ideas that
stand out from the crowd?
Subscribe now and receive a full year of
Value Investor Insight – including
weekly e-mail bonus content and
access to all back issues – for only $349.
That’s less than $30 per month!
Subscribe Online »
Mail-in Form »
Fax-in Form »
Want to learn more?
Please visit www.valueinvestorinsight.com
February 28, 2010
is more likely to grow at 4.5% to 5% per
year. On top of potential revenue syner-
gies, there are plenty of costs to be cut as
well. Kraft management has so far identi-
fied $675 million in annual cost savings,
ON THE CADBURY PRICE:
Buffett’s making a stink about
the price Kraft was paying for
Cadbury did a real service to
Kraft shareholders.
a number Ackman expects to increase.
Add it all up, and by 2012 Ackman
estimates Kraft will be earning $2.70 to
$2.90 per share. At a minimum 15x mul-
tiple – “still way too low for a company
of this quality,” he says – Kraft shares
would trade at $40 to $44 per share.
With the 4% annual dividend yield, that
would translate to a 50%-60% return
from Kraft's current price of $28.40.
“The biggest risk is whether [CEO] Irene
Or call toll-free:
866-988-9060
www.valueinvestorinsight.com
U N C O V E R I N G V A L U E : Kraft
Rosenfeld and her team execute to
achieve the potential that's here,” he says.
“How do we lose a lot of money? I don't
see it, given how the quality of the exist-
ing business more than supports the cur-
rent valuation. We think it's more a ques-
tion of how long it takes them to execute
than whether they're able to get it done.”
And what of Warren Buffett's protes-
tations that Kraft agreed to pay too dear
a price for Cadbury? Ackman argues that
given the expected margin improvement
at Cadbury and assuming the announced
cost savings targets are met, Kraft is pay-
ing only 12x what he expects the compa-
ny to earn after taxes in 2011. That's a
significant discount, he adds, to what
Mars paid in 2008 for Wrigley – a deal
partly funded by Berkshire Hathaway.
“Buffett's making a stink about the price
Kraft was paying did a real service to
Kraft shareholders,” Ackman says. “I'm
sure it helped the Cadbury board feel like
they were doing a great job in selling the
company.” VII
To view Pershing Square’s presentation on
Kraft, “A Krafty Combination,”click here.
Value Investor Insight 20

“Boring is likely to be better”
High-quality companies that best weathered the crisis weren't the biggest stock-market winners over the past
year. Brown Brothers’ Tim Hartch and Michael Keller don’t expect that to be the case in the coming one.
Financial markets were crumbling, but
there was no sense of panic in last year's
interview (VII, February 23, 2009) with
Tim Hartch and Michael Keller of Brown
Brothers Harriman & Co. As Hartch
summed up their approach at the time:
“When their stocks are on sale, we think
buying into leading companies that pro-
vide essential products to large, loyal cus-
tomer bases is always a strategy for doing
well. That's going to prove more impor-
tant today than ever.”
Hartch and Keller saw particular value
in five stocks – Chubb, Aflac, Intuit, eBay
and Dentsply – an equally weighted port-
folio of which to-date would have
returned 74% since the issue appeared,
vs. a 46% gain for the Russell 3000. But
Hartch still believes the types of blue-chip
companies he favors are getting relatively
short shrift from today's market. “Many
of the best companies have come through
the past twelve months in excellent
shape,” he says, “but haven't fully partic-
ipated in the market rebound.
He cites Chubb as a prime example.
The property/casualty insurer, known for
its high-end property and professional-
liability lines, had an excellent 2009: it
earned $6.20 per share, up 25% over the
prior year; its combined ratio (insurance
expenses and losses divided by premium
income) came in at an impressive 86%; its
investment portfolio remained remark-
ably clean and rebounded nicely as credit
markets improved; overall, the firm's
book value increased 23% from year-end
2008. Despite all that, while the compa-
ny's shares have rebounded off March
2009 lows, at just over $50 they are at the
same level they were at the end of 2008.
The primary weight on the stock, says
Hartch, is malaise in the property/casual-
ty insurance business. Slack demand due
to the economy and a surfeit of industry
capital are exerting downward pressure
on prices. Rather than chase sales by cut-
February 28, 2010
A F R E S H L O O K : Chubb
ting rates, Chubb has been turning away equity to translate over time into compa-
business on which it doesn't expect to rable annual returns for shareholders –
earn an adequate return. As a result, its through increases in book value, divi-
net written premiums fell 6% last year, dends, and share buybacks. One fly in the
and Hartch believes they may fall again ointment, he says, would be a sharp rise
this year. “Wall Street hates to see that,” in interest rates, which would negatively
he says, “but the long-term benefit of impact the market value of Chubb's giant
maintaining pricing discipline exceeds the fixed-income investment portfolio.
short-term cost of lost premiums.” “There's no exciting catalyst or dra-
Chubb shares trade for less than 1.1x matic turnaround story here,” says
book value, well off their traditional mid- Hartch, “but this is the type of low-risk
cycle valuation of closer to 1.5x. Even opportunity we're finding most attractive
with no re-rating of the shares, Hartch today. Boring is likely to be better in the
expects the company's 15% returns on next twelve months.” VII
INVESTMENT SNAPSHOT
Chubb
(NYSE: CB)
CB PRICE HISTORY
80 80
70 70
60 60
50 50
!
40 40
30 30
2008 2009 2010
! VII, February 23, 2009
Share Information (@2/26/10): Valuation Metrics (@2/26/10):
Price $50.46 CB S&P 500
52-Week Range $34.44 – $53.79 Trailing P/E 8.2 21.8
Forward P/E Est. 9.1 14.1
ORIGINAL BOTTOM LINE – FEBRUARY 23, 2009
In painting its shares with the same negative brush being used on all insurers, the mar-
ket is not recognizing the company’s competitive strengths in underwriting, customer
service and financial management, says Tim Hartch. His discounted cash flow analysis
indicates an intrinsic value for the shares of closer to $75, nearly twice today’s level.
NEW BOTTOM LINE
Malaise in property/casualty insurance has only highlighted the company’s operational
strength, says Tim Hartch, who expects its typical 15% ROE to yield a comparable
return for shareholders. Eventual multiple expansion provides further upside, he says.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com Value Investor Insight 21

The Forgotten Lessons of 2008
In this excerpt from his annual letter, investing great Seth Klarman describes 20 lessons from the financial crisis
which, he says, “were either never learned or else were immediately forgotten by most market participants.”
Editors’ Note: As we approach the one-
year anniversary of March 9, 2009, the
day the market hit what we suspect will
prove to be a generational low, it’s an
excellent time to reflect on the lessons of
the market’s collapse and subsequent
rebound. And who better to provide per-
spective than Baupost Group’s Seth
Klarman, who has given us permission to
publish the following excerpt from his
new annual letter, in which he describes
20 lessons that should have been learned
from the crisis … as well as 10 wrong les-
sons investors appear to have learned
instead.
One might have expected that the
near-death experience of most investors
in 2008 would generate valuable lessons
for the future. We all know about the
“depression mentality” of our parents
and grandparents who lived through the
Great Depression. Memories of tough
times colored their behavior for more
than a generation, leading to limited risk
taking and a sustainable base for healthy
growth. Yet one year after the 2008 col-
lapse, investors have returned to shock-
ingly speculative behavior. One state
investment board recently adopted a plan
to leverage its portfolio – specifically its
government and high-grade bond hold-
ings – in an amount that could grow to
20% of its assets over the next three
years. No one who was paying attention
in 2008 would possibly think this is a
good idea.
Below, we highlight the lessons that we
believe could and should have been
learned from the turmoil of 2008. Some
of them are unique to the 2008 melt-
down; others, which could have been
drawn from general market observation
over the past several decades, were cer-
tainly reinforced last year. Shockingly, vir-
tually all of these lessons were either
never learned or else were immediately
forgotten by most market participants.
February 28, 2010
Twenty Investment Lessons of 2008
1. Things that have never happened
before are bound to occur with some
regularity. You must always be pre-
pared for the unexpected, including
sudden, sharp downward swings in
markets and the economy. Whatever
adverse scenario you can contem-
plate, reality can be far worse.
2. When excesses such as lax lending
standards become widespread and
persist for some time, people are
lulled into a false sense of security,
creating an even more dangerous situ-
ation. In some cases, excesses migrate
beyond regional or national borders,
raising the ante for investors and gov-
ernments. These excesses will eventu-
ally end, triggering a crisis at least in
proportion to the degree of the
excesses. Correlations between asset
classes may be surprisingly high when
leverage rapidly unwinds.
3. Nowhere does it say that investors
should strive to make every last dollar
of potential profit; consideration of
risk must never take a backseat to
return. Conservative positioning enter-
ing a crisis is crucial: it enables one to
maintain long-term oriented, clear
thinking, and to focus on new oppor-
tunities while others are distracted or
even forced to sell. Portfolio hedges
must be in place before a crisis hits.
One cannot reliably or affordably
increase or replace hedges that are
rolling off during a financial crisis.
4. Risk is not inherent in an investment;
it is always relative to the price paid.
Uncertainty is not the same as risk.
Indeed, when great uncertainty – such
as in the fall of 2008 – drives securities
prices to especially low levels, they
often become less risky investments.
5. Do not trust financial market risk
models. Reality is always too com-
plex to be accurately modeled.
www.valueinvestorinsight.com
S T R A T E G Y : Seth Klarman
Attention to risk must be a 24/7/365
obsession, with people – not comput-
ers – assessing and reassessing the risk
environment in real time. Despite the
predilection of some analysts to
model the financial markets using
sophisticated mathematics, the mar-
kets are governed by behavioral sci-
ence, not physical science.
6. Do not accept principal risk while
investing short-term cash: the greedy
effort to earn a few extra basis points
of yield inevitably leads to the incur-
rence of greater risk, which increases
the likelihood of losses and severe
illiquidity at precisely the moment
when cash is needed to cover expens-
es, to meet commitments, or to make
compelling long-term investments.
7. The latest trade of a security creates a
dangerous illusion that its market
price approximates its true value.
This mirage is especially dangerous
during periods of market exuberance.
The concept of "private market
value" as an anchor to the proper val-
uation of a business can also be great-
ly skewed during ebullient times and
should always be considered with a
healthy degree of skepticism.
8. A broad and flexible investment
approach is essential during a crisis.
Opportunities can be vast, ephemeral,
and dispersed through various sectors
and markets. Rigid silos can be an
enormous disadvantage at such times.
9. You must buy on the way down. There
is far more volume on the way down
than on the way back up, and far less
competition among buyers. It is almost
always better to be too early than too
late, but you must be prepared for
price markdowns on what you buy.
10. Financial innovation can be highly
dangerous, though almost no one will
tell you this. New financial products
are typically created for sunny days
and are almost never stress-tested for
Value Investor Insight 22

stormy weather. Securitization is an
area that almost perfectly fits this
description; markets for securitized
assets such as subprime mortgages
completely collapsed in 2008 and
have not fully recovered. Ironically,
the government is eager to restore the
securitization markets back to their
pre-collapse stature.
11. Ratings agencies are highly conflict-
ed, unimaginative dupes. They are
blissfully unaware of adverse selec-
tion and moral hazard. Investors
should never trust them.
12. Be sure that you are well compensated
for illiquidity – especially illiquidity
without control – because it can create
particularly high opportunity costs.
13. At equal returns, public investments
are generally superior to private
investments not only because they are
more liquid but also because amidst
distress, public markets are more like-
ly than private ones to offer attractive
opportunities to average down.
14. Beware leverage in all its forms.
Borrowers – individual, corporate, or
government – should always match
fund their liabilities against the dura-
tion of their assets. Borrowers must
always remember that capital markets
can be extremely fickle, and that it is
never safe to assume a maturing loan
can be rolled over. Even if you are
unleveraged, the leverage employed by
others can drive dramatic price and
valuation swings; sudden unavailabili-
ty of leverage in the economy may
trigger an economic downturn.
15. Many LBOs are man-made disasters.
When the price paid is excessive, the
equity portion of an LBO is really an
out-of-the-money call option. Many
fiduciaries placed large amounts of
the capital under their stewardship
into such options in 2006 and 2007.
16. Financial stocks are particularly risky.
Banking, in particular, is a highly lever-
aged, extremely competitive, and chal-
lenging business. A major European
bank recently announced the goal of
achieving a 20% return on equity
(ROE) within several years.
Unfortunately, ROE is highly depend-
February 28, 2010
ent on absolute yields, yield spreads,
maintaining adequate loan loss
reserves, and the amount of leverage
used. What is the bank's management
to do if it cannot readily get to 20%?
Leverage up? Hold riskier assets?
Ignore the risk of loss? In some ways,
for a major financial institution even
to have a ROE goal is to court disaster.
17. Having clients with a long-term ori-
entation is crucial. Nothing else is as
important to the success of an invest-
ment firm.
18. When a government official says a
problem has been "contained," pay
no attention.
19. The government – the ultimate short-
term-oriented player – cannot with-
stand much pain in the economy or
the financial markets. Bailouts and
rescues are likely to occur, though not
with sufficient predictability for
investors to comfortably take advan-
tage. The government will take enor-
mous risks in such interventions,
especially if the expenses can be con-
veniently deferred to the future. Some
of the price-tag is in the form of back-
stops and guarantees, whose cost is
almost impossible to determine.
20. Almost no one will accept responsi-
bility for his or her role in precipitat-
ing a crisis: not leveraged speculators,
not willfully blind leaders of financial
institutions, and certainly not regula-
tors, government officials, ratings
agencies or politicians.
Below, we itemize some of the quite
different lessons investors seem to have
learned as of late 2009 – false lessons, we
believe. To not only learn but also effec-
tively implement investment lessons
requires a disciplined, often contrary, and
long-term-oriented investment approach.
It requires a resolute focus on risk aver-
sion rather than maximizing immediate
returns, as well as an understanding of
history, a sense of financial market cycles,
and, at times, extraordinary patience.
False Lessons
1. There are no long-term lessons – ever.
www.valueinvestorinsight.com
S T R A T E G Y : Seth Klarman
2. Bad things happen, but really bad
things do not. Do buy the dips, espe-
cially the lowest quality securities
when they come under pressure,
because declines will quickly be
reversed.
3. There is no amount of bad news that
the markets cannot see past.
4. If you’ve just stared into the abyss,
quickly forget it: the lessons of histo-
ry can only hold you back.
5. Excess capacity in people, machines,
or property will be quickly absorbed.
6. Markets need not be in sync with one
another. Simultaneously, the bond
market can be priced for sustained
tough times, the equity market for a
strong recovery, and gold for high
inflation. Such an apparent discon-
nect is indefinitely sustainable.
7. In a crisis, stocks of financial compa-
nies are great investments, because
the tide is bound to turn. Massive
losses on bad loans and soured invest-
ments are irrelevant to value; improv-
ing trends and future prospects are
what matter, regardless of whether
profits will have to be used to cover
loan losses and equity shortfalls for
years to come.
8. The government can reasonably rely
on debt ratings when it forms pro-
grams to lend money to buyers of oth-
erwise unattractive debt instruments.
9. The government can indefinitely con-
trol both short-term and long-term
interest rates.
10. The government can always rescue
the markets or interfere with contract
law whenever it deems convenient
with little or no apparent cost.
(Investors believe this now and, worse
still, the government believes it as
well. We are probably doomed to a
lasting legacy of government tamper-
ing with financial markets and the
economy, which is likely to create the
mother of all moral hazards. The gov-
ernment is blissfully unaware of the
wisdom of Friedrich Hayek: “The
curious task of economics is to
demonstrate to men how little they
really know about what they imagine
they can design.”) VII
Value Investor Insight 23
General Publication Information and Terms of Use

Value Investor Insight and SuperInvestor Insight are published at www.valueinvestorinsight.com (the “Site”) by Value Investor Media, Inc. Use
of this newsletter and its content is governed by the Site Terms of Use described in detail at www.valueinvestorinsight.com/misc/termsofuse. For
your convenience, a summary of certain key policies, disclosures and disclaimers is reproduced below. This summary is meant in no way to
limit or otherwise circumscribe the full scope and effect of the complete Terms of Use.

No Investment Advice
This newsletter is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solic-
itation would be illegal. This newsletter is distributed for informational purposes only and should not be construed as investment advice
or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a gen-
eral or personal recommendation or take into account the particular investment objectives, financ ial situations, or needs of individual
investors. The price and value of securities referred to in this newsletter will fluctuate. Past performance is not a guide to future
performance, future returns are not guaranteed, and a loss of all of the original capital invested in a security discussed in this newslet-
ter may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are
not suitable for all investors.

Disclaimers
There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth in
this newsletter. Value Investor Media will not be liable to you or anyone else for any loss or injury resulting directly or indirectly from
the use of the information contained in this newsletter, caused in whole or in part by its negligence in compiling, interpreting, reporting
or delivering the content in this newsletter.

Related Persons
Value Investor Media’s officers, directors, employees and/or principals (collectively “Related Persons”) may have positions in and may,
from time to time, make purchases or sales of the securities or other investments discussed or evaluated in this newsletter.

Whitney Tilson, Chairman of Value Investor Media, is also a principal of T2 Partners Management, LP, a registered investment adviser.
T2Partners Management, LP may purchase or sell securities and financial instruments discussed in this newsletter on behalf of certain
accounts it manages.

It is the policy of T2 Partners Management, LP and all Related Persons to allow a full trading day to elapse after the publication of this
newsletter before purchases or sales are made of any securities or financial instruments discussed herein as Investment Snapshots.

Compensation
Value Investor Media, Inc. receives compensation in connection with the publication of this newsletter only in the form of subscription
fees charged to subscribers and reproduction or re-dissemination fees charged to subscribers or others interested in the newsletter
content.

February 28, 2010 www.valueinvestorinsight.com Value Investor Insight