Vous êtes sur la page 1sur 75


Whitney R. Tilson and Glenn H. Tongue phone: 212 386 7160

Managing Partners fax: 240 368 0299

January 8, 2009

Dear Partner,

We hope you had wonderful holidays and wish you a happy New Year!

In each of our annual letters we seek to frankly assess our performance, reiterate our core investment
philosophy and share our latest thinking about various matters. In addition, we disclose and discuss our
10 largest positions in the hopes that you will share the confidence we have in our fund’s future
prospects, which in our opinion have never been brighter.

Our fund had a poor December, capping a dreadful quarter and a disappointing year:

Total Annualized
Since Since
December 4th Quarter Full Year Inception Inception
T2 Accredited Fund - gross -4.0% -24.1% -18.1% 128.5% 8.6%
T2 Accredited Fund - net -4.0% -23.0% -18.1% 88.3% 6.5%
S&P 500 1.1% -22.0% -37.0% -13.1% -1.4%
Wilshire 4500 3.5% -27.9% -39.8% -3.0% -0.3%
Dow -0.4% -18.4% -31.9% 18.4% 1.7%
NASDAQ 2.7% -24.4% -40.0% -26.9% -3.1%

This chart shows our performance since inception:




(%) 60


Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan- Jul- Jan-
99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09

T2 Accredited Fund S&P 500

Past performance is not indicative of future results. Please refer to the disclosure section at the end of this letter. The T2 Accredited Fund was launched on
1/1/99. Its returns are after all fees. Gains and losses among private placements are only reflected in the returns since inception.

145 E. 57th Street, 10th Floor, New York, NY 10022

Performance Objectives
In every year-end letter we repeat our performance objectives, which have been the same since our
fund’s inception: Our primary goal is to earn you a compound annual return of at least 15%, measured
over a minimum of a 3-5 year horizon.

We arrived at that objective by assuming the overall stock market is likely to compound at 5-10%
annually over the foreseeable future, and then adding 5-10 percentage points for the value we seek to
add, which reflects our secondary objective of beating the S&P 500 by 5-10 percentage points annually
over shorter time periods. While a 15% compounded annual return might not sound very exciting, it
would quadruple your investment over the next 10 years, while 7-8% annually – about what we expect
from the overall market – would only double your money.

Since inception 10 years ago, we have not met our 15% objective, thanks in part to a weak market, but
have outperformed the S&P 500 by 7.9 percentage points per year, within our 5-10 percentage point
goal. There are few funds that have beaten the market by this margin over the past decade, but we are
not satisfied with our performance and aim to improve upon it.

Performance Assessment
Had you told us last January that our prediction of much pain and suffering in the housing sector, which
would have a devastating impact the nation’s financial institutions, would be proven absolutely correct,
and that the resulting gains in our short book would be a major contributor to our fund outperforming the
S&P 500 by nearly 20 percentage points (our second-best year ever relative to the markets), we would
have eagerly looked forward to a good year. But it wasn’t a good year, especially the last quarter.

It is particularly galling to us because we correctly identified the housing bubble and anticipated its
bursting, so we avoided nearly all investments in the real estate and financial sectors. Our mistake, as
we discuss in detail below, is that we failed to see how widespread the damage would be. We thought
the bursting of the bubble would create a significant economic headwind, to be sure, but not cause the
near-Armageddon fallout that instead occurred, so we left the portfolio exposed to many retail and
consumer-related stocks, which have been crushed.

We take pride in our work, have our reputations and financial well being at stake, and are accustomed to
consistently beating the market and making money, so the past year was disappointing.

That said, we’ve gone through rough patches before and have always rebounded strongly. Because we
manage a concentrated portfolio, over short periods of time – and we consider one quarter a very brief
period in light of our typical 3-5 year investment horizon – our results can be volatile, so we want to be
careful not to overreact. Frustration and its companion, impatience, are the enemies of successful value

We are determined to improve our performance, but will not change our core investment philosophy and
approach. Rather, we will work even harder to expand our circle of competence, learn from our
experiences – both positive and negative – and patiently seek out the best opportunities.

We’re pleased to report that thanks to the unprecedented volatility and carnage in the markets, we’re
finding many wonderful investments that we think are deeply undervalued and poised to provide future
outperformance. We have the highest degree of conviction in our current portfolio that we’ve ever had
and hope that this letter – in particular, the discussion of our 10 largest positions – helps you share our

An article in The Wall Street Journal last week about the travails of many hedge funds had a paragraph
that summarized the opportunity we believe exists:

All’s not lost for hedge funds, however. Survivors of 2008’s market tsunami likely will enjoy lucrative
opportunities amid much less competition. As many as half the hedge funds that began 2008 could close,
or be short of cash, as the new year unrolls. Those with cash on hand and a stable investor base will be
able to take advantage of bargains in stocks and various debt markets.

Overview of 2008
It was an extraordinary year – so much so that we suspect we will tell our grandchildren about surviving
the Great Bear Market of 2008. In our 2002 annual letter, we wrote that “there were few places to hide
as the bear market extended to stocks of nearly every type” – and this was even more true last year.
Fortunately, however, we’ve added shorting to our toolkit since then – and, as we discuss below, it made
quite a difference.

In 2008, the Nasdaq had its worst year since its inception in 1971 while the Dow and S&P had their
worst years since the 1930s. The S&P had its 3rd worst year ever going back to 1825, as the chart in
Appendix A shows. In total, an estimated $7 trillion of U.S. stockholder wealth evaporated in 2008.

Even more remarkably, the U.S. was one of the best performing markets in the world, as the average
developed country market (excluding the U.S.) fell 45%, while emerging markets plunged an average of
55%. Japan had its worst year ever, down 42%, while the popular BRIC markets (Brazil, Russia, India
and China) tumbled 41%, 67%, 52% and 65%, respectively. Worldwide stock market losses were
approximately $30 trillion. The average long-short hedge fund was down 26% through November.

Market volatility was unprecedented. After Lehman Brothers sank into bankruptcy in September, the
S&P 500 had moves of at least 5% on 18 days, more than the 17 such days in the previous 53 years.

To shed light on how the market turbulence impacted our portfolio in 2008, we’d like to focus on three
stories that summarize the year: a home run, a costly error and a question mark.

A Home Run
As noted above, we correctly identified the housing bubble and anticipated its bursting, so we avoided
nearly all long investments in the real estate and financial sectors and aggressively shorted stocks in
these sectors and beyond. In total, we profitably shorted a wide range of stocks during the year, 23 of
which contributed more than 50 basis points of performance during the year vs. only one that cost us
more than 36 basis points (Usana, 59 bps). Thank goodness we did so or 2008 would have been a total

As discussed on the next page, we profitably shorted stocks in a wide range of sectors, but the single
greatest concentration was in the financial sector, where we had profitable shorts among the bond
insurers (Ambac and MBIA), GSEs (Fannie Mae, Farmer Mac and Freddie Mac), investment banks
(Bear Stearns and Lehman Brothers), large banks (Bank of America, Wachovia and Washington
Mutual), regional banks (Regions Financial and Zions Bancorp), REITs (Boston Properties, General
Growth, Macerich and Simon Properties), mortgage insurers (MGIC, PMI and Radian), as well as AIG,
Allied Capital, Capital One Financial and Moody’s.

It is safe to say that we will never have a year like 2008 again on the short side, but we believe we can
continue to both hedge our portfolio and generate positive returns through selective shorting going

A Costly Error
In last year’s annual letter, we’re embarrassed to admit that we wrote the following:

The primary reason for our fund’s recent underperformance is its exposure to the retail sector, which in
2007 was the second-worst-performing sector in the market after financials. We didn’t decide to make a
sector bet on retail – rather, we own each stock on its own merits – yet one might reasonably ask, “Don’t
you guys read the papers? Don’t you know that the U.S. consumer is getting hurt by the bursting of the
housing bubble, the credit crunch, higher gas prices, etc.?”

Our answer: of course we’re aware of this and the possibility that things could get even worse, but:

A) While we wish we had the ability to predict macro factors, we don’t, so when we find a cheap
stock that we think has low risk of permanent loss of capital as well as strong upside
potential, we usually don’t let worries about macro factors deter us from buying it. We focus
on analyzing and understanding micro factors such as a company’s margins and future
growth prospects, industry competitive dynamics, etc. rather than trying to predict when the
housing bubble will finish deflating, the direction of interest rates, oil prices, the overall
economy, etc.

B) The American economy and consumer have proven to be remarkably resilient and our
experience and numerous studies show that when experts are unanimous in their opinion on
some macro factor, they’re wrong more often than not.

C) Finally, we think a great deal of negativity about the U.S. economy and consumer spending is
already built into the prices of the stocks we own.

In hindsight, which is always 20/20, we were too early but we believe we will ultimately be proven
correct and earn large gains in these investments.

It turns out that: A) We should have paid more attention to our macro views; B) The American economy
and consumer were not resilient and the consensus opinion was correct; and C) A whole lot more well-
deserved negativity about the U.S. economy and consumer spending got built into the prices of the
stocks we owned. 2008 was a good reminder that to be a successful value investor, it’s not enough to be
a contrarian. Yes, you must have what Michael Steinhardt calls a “variant perception”, but you also
have to be right! We have learned our lesson and have trimmed many of our retail positions.

In our defense, we partially hedged our long exposure in the retail/consumer sector by profitably
shorting numerous richly valued stocks such as Amazon.com, America’s Car-Mart, Apple, Best Buy,
Blyth, Conns, Crocs, Gamestop, Garmin, Hanesbrands, Heelys, Herbalife, Lululemon Athletica, Martha
Stewart Living Omnimedia, Monster Worldwide, Nutrisystem, Omniture, OptionsExpress, Planar, Rent-
A-Center, Research in Motion, Rick’s Cabaret, Ryder, St. Joe, Under Armour, Urban Outfitters and
VistaPrint. In addition, our highly successful REIT shorts noted on the previous page were in part to
hedge our exposure to Target and Sears. Unfortunately, however, our retail/consumer short book was
much smaller than our long one.

In summary, last year we could plausibly argue that we were early, not wrong. We can no longer do so.

We failed to anticipate the fallout from the bursting of The Great Mortgage Bubble, which was a very
expensive mistake.

A Question Mark
This chart shows our performance during 2008 relative to the three major indices:

As you can see, we had a spectacular month in September and by the end of the month were up on the
year, but then proceeded to track the market during a terrible fourth quarter. What happened? In short,
two things: 1) in general, we were too early in trimming our shorts and adding to our long book; and 2)
we focused our buying on deeply out-of-favor stocks that we thought had been beaten down to an
excessive degree due to irrational forced selling – and the distress got much worse.

The reason we call this a question mark rather than a mistake is that it’s not yet clear whether we were
early or wrong. In any case, there’s no doubt that we were too early. In our October letter, we wrote:

With stocks down so much, we have made the conscious decision to be more long and less short, as we see
much more upside in the stocks we own and less downside in the stocks we’re short.

The last point is the most important one, rooted in one of our favorite Buffett quotes: “…be fearful when
others are greedy and greedy when others are fearful.” In our investment careers, other investors had never
been more fearful as they were in mid-October – and we had never felt so enthusiastic. Even today,
everywhere we look we are seeing some of the most extraordinary opportunities we’ve ever seen. Berkshire
and Fairfax are among the least undervalued stocks in our portfolio, in our opinion – which is OK, because
we believe that in addition to decent appreciation potential, they provide protection against a further market

We cannot say when this panic will subside, how much worse things will get or how quickly stocks might
rebound, but we are prepared for the worst and have never felt greater certainty that we will be well rewarded
by the stocks we own at current prices if we remain calm and patient.

With the benefit of hindsight (which is always 20/20), we were at least a couple of months too early in
trimming our short positions and investing in the long opportunities we identified. The economic
downturn worsened and this, combined with deleveraging, redemptions, year-end tax selling and
widespread investor panic, led many cheap stocks to become much, much cheaper.

Our portfolio was not immune and we suffered awful Q4 losses among many of our long positions, the
most painful of which were Borders (-93.9%), Crosstex (-84.4%), Huntsman (-72.7%), Resource
America (-57.9%) and EchoStar (-38.3%). All except Borders and Resource America are among our top
10 positions and are therefore discussed in Appendix B.

As for Borders, a perfect storm of a terrible macro environment, poor management and too much debt
have led investors to conclude that Borders will likely have to file for bankruptcy, wiping out
shareholders. There is a very real chance of this outcome, but if Borders survives its stock could rise
many-fold so we continue to hold a small position. We were heartened by the recent news that the
company has brought in a new CEO with an outstanding track record.

Borders reminds us of a stock we once owned, Denny’s, which also had a tiny sliver of market cap on
top of a big pile of debt. Such stocks often go to zero, but if they recover the gains can be remarkable.
Denny’s, for example, hit a low of 23 cents at the end of 2003 in part due to year-end tax selling. Over
the next 19 months, it rose more than 26x as this chart shows:

The Importance of Patience

Our value-oriented investment approach often involves buying out-of-favor stocks. Such stocks
sometimes fall further after we buy them and, even if they don’t, they almost always take some time to
recover. Famed investor John Templeton once said, “If you find shares that are low in price, they don’t
suddenly go up. Our average holding period is five years” and Baupost’s Seth Klarman once wrote at the

end of a particular difficult year, “Being very early and being wrong look exactly the same 99% of the

In every investment we make, we are essentially betting against the market – betting that the herd is
failing to appreciate, in pricing a stock where it is, the strengths of a particular company and the future
cash flows that it will generate. There are two dangers to such bets: we could be wrong or, even if we’re
ultimately proven right, the herd could become even more irrational in the short term. In both cases our
fund’s returns may suffer initially, but there’s a huge difference over time if we are correct in assessing
the value of a company. The key is to buy significantly undervalued stocks and then for all of us to have
the intestinal fortitude to see the investments through to fruition. For example, among our 10 largest
positions, discussed below, we are underwater on half of them (Winn-Dixie, Huntsman, Crosstex,
dELiA*s and Echostar), but in each case think we will end up making money.

Michael Steinhardt, who made investors about 500 times their money over 30 years, once commented:

The hardest thing over the years has been having the courage to go against the dominant wisdom of the
time, to have a view that is at variance with the present consensus and bet that view. The hard part is that
an investor must measure himself not by his own perceptions of his performance but by the objective
measure of the market. The market has its own reality. In an immediate, emotional sense, the market is
always right. So if you take a variant point of view, you will always be bombarded for some period of
time by the conventional wisdom as expressed by the market.

2009 Outlook and How We’ve Positioned Our Fund

We continue to believe that the U.S. economy is in the midst of a severe recession that will be more
painful and long-lasting than economists are forecasting. Specifically, economists are predicting that
U.S. GDP will shrink in the first two quarters of 2009 and then resume growing in the second half. Our
instinct is that GDP will decline for the entire year, be roughly flat in 2010 and then begin growing at a
tepid rate. Only the large scale stimulus package and tax cut that will likely be passed in the next month
or so by the new administration and Congress will stave off a more dire outcome.

If we are correct, then corporate earnings will be very weak and difficult to forecast in 2009. Thus, we
have trimmed many of our long positions that we were valuing based on a multiple of earnings – for
example, Target and Barnes & Noble – because we don't think the earnings will be there anytime soon.
Instead, we have focused our portfolio on two kinds of stocks: 1) Ones that we believe are massively
oversold due to technical factors such as tax-loss selling and redemptions/liquidations (see examples
discussed below); and 2) Stocks trading at a discount to cash or liquidation value, such as dELiA*s and
Echostar, in which we think we’ll make money almost regardless of what the earnings are.

On the short side, we have trimmed (and, in some case, have entirely covered) many of our most
profitable positions, as the stocks have fallen to our target prices. However, we continue to hold a
number of shorts, the 10 largest of which are (in alphabetical order): Capital One Financial, KB Home,
Lennar, MBIA, Moody’s, Netflix, Retail HOLDRs (RTH), Simon Property Group, VistaPrint and Wells

The Opportunity in Small-Cap, Out-of-Favor Stocks

We think there are particularly compelling opportunities in small-cap stocks in out-of-favor sectors such
as Crosstex, dELiA*s, Huntsman, Resource America and Winn-Dixie. Such stocks are particularly
vulnerable to year-end tax selling and forced selling due to funds delevering, getting hit with
redemptions and/or closing their doors. When this happens, fund managers need to sell their holdings
irrespective of value – and in the case of small-cap stocks, even a single motivated seller can crash a

stock 10%, 20% or more. We don’t like being in the position of owning stocks being hit with this type
of selling, but we much prefer it to voluntary selling by rational investors. In the former case, as long as
one has patience and courage (and, of course, is right about the intrinsic value), we believe stock
performance should improve when the forced selling ends, as it eventually does.

In some cases, we’re taking advantage of forced selling by buying stocks at distressed prices, but we are
being selective because we want to maintain flexibility and liquidity in our portfolio and also don’t want
to buy a stock today when there’s a motivated seller who will be back in the market tomorrow, likely
driving it lower still. At least year-end tax selling is now behind us.

Small-cap companies exposed to the U.S. economy and consumer are in a severe bear market, far worse
than anything we’ve ever seen. At current prices, we are delighted to own a number of these stocks –
four of our top six positions have market caps of less than $1 billion – though we certainly regret
purchasing them too early. It’s important to note, however, that our investing strategy does not depend
on great timing. We think it’s impossible for anyone to consistently buy stocks at their bottoms – and
we know we can’t do it. Rather, we focus on being right about the businesses and their intrinsic values.

To this end, we never stop analyzing our positions. In particular, whenever we own a stock that has
declined materially, we reassess the investment with an open mind and do one of three things: a) If we
conclude that we’ve made a mistake and a margin of safety no longer exists, we’ll sell; b) If intrinsic
value has declined, but the stock has declined proportionally, such that there’s still a healthy margin of
safety, we’ll usually hold; or c) If intrinsic value has remained constant or risen while the stock has
declined, meaning the margin of safety is even greater, we’ll typically buy more.

We remain patient and vigilant, enhance our portfolios wherever we can, and believe we are well-
positioned for a more favorable environment. Our experience has been that the periods of recovery are
very rewarding.

While we are disappointed by our fund’s recent performance, overall we feel extraordinarily enthusiastic
about its prospects going forward and continue have most of our own net worths invested in our funds
alongside you. We choose to eat home cooking not only out of habit, not only because we should, and
not only so we can tell you that we do, but because we have a great deal of confidence in our strategy
and can’t think of a better place to invest our money.

Discussion of Our 10 Largest Long Positions

In Appendix B we discuss our 10 largest long positions across all three hedge funds we manage, which
are (in descending order of size, as of 12/31/08):

1) Berkshire Hathaway
2) Wendy’s
3) Winn-Dixie
4) Huntsman
5) Crosstex
6) dELiA*s
7) Wal-Mart
8) Fairfax Financial/Odyssey Re
9) EchoStar
10) Distressed debt position (RMBS tranche)

We want to acknowledge and thank Damien Smith, who has been an outstanding analyst for us for
nearly six years, and Kelli Alires, who does a fabulous job as office manager.

We are also delighted to let you know that Chris Woolford has joined us as an analyst (making us, we
suspect, the only investment fund in the world that has increased its head count by 25% this year!).
We’ve known Chris for many years and he is an exceptionally high-grade person and analyst. His bio is
attached in Appendix H.

We say this at the end of every letter, but we genuinely mean it when we thank you for your continued
confidence in us and the fund, especially during times like these. Most of our personal assets are
invested in the funds we manage, along with substantial investments from many close friends and family
members, so we are in this together and are fully committed to generating superior long-term returns for
all of us.

As always, we welcome your comments so please don’t hesitate to call us at (212) 386-7160.

Sincerely yours,

Whitney Tilson and Glenn Tongue

Appendix A: Distribution of S&P 500 Returns Since 1825

Source: Value Square Asset Management, Yale University

Appendix B: 10 Largest Positions
Note: The stocks are listed in descending order of size, cumulatively across all three hedge funds we
manage, as of 12/31/08.

1) Berkshire Hathaway
In every investment, we look for securities that we believe are safe, rapidly growing and cheap – and
Berkshire has all three in spades. It has one of the few AAA credit ratings in the world, is flush with a
huge cash hoard (despite making approximately $50 billion of commitments in 2008), is one of the
fastest growing large companies in America (earnings of Berkshire’s operating businesses grew at a
23.5% compounded rate from 1993-2007), and we estimate that it trades at approximately a 30%
discount to intrinsic value. In addition, it has exemplary corporate governance and is overseen by
Warren Buffett, perhaps the world’s greatest capital allocator. In Appendix C is our latest slide
presentation on Berkshire.

Berkshire’s stock was down 31.8% in 2008, but our losses were quite a bit lower because we took
advantage of a brief window of absolute madness in the market. In November, Berkshire’s shares fell
nearly 40 per cent in two weeks – to an intraday low of $74,100 – and its credit default swap spreads
widened to junk levels based primarily on absurd rumors the company faced huge losses and possibly a
liquidity squeeze.

On November 20th, the very day the stock bottomed (closing at $77,500), we published an article (see
Appendix D) rebutting the nonsense in the marketplace. We also doubled our position and benefitted
greatly as the stock rallied 25% by the end of the year.

There’s no question that Berkshire has been impacted by the deteriorating macro environment. As you
can see in our slide presentation, we have trimmed our estimate of intrinsic value from $157,000 to
$136,000, and we estimate that Berkshire’s book value declined by 10% in 2008, its steepest decline
ever, as the table below shows. Note, however, that a 10% decline during a year in which the S&P 500
declined 37% is actually quite remarkable and is, in fact, the 2nd best relative performance in the past 27

One might look at the carnage in the market and conclude that, while Berkshire might be cheap, there
are many far cheaper stocks. We agree. Berkshire is probably the least cheap stock in our portfolio, but
we own it because it’s so safe. Most of the rest of our portfolio is in extraordinarily beaten-down stocks
or special situations, many of which are discussed below.

2) Wendy’s
Following its recent merger with Triarc Companies, Wendy’s is now being run by Nelson Peltz and his
team, top operators and capital allocators who engineered a remarkable turnaround at Arby’s – a
significantly inferior business to Wendy’s – and are a good bet, we believe, to do the same with

We know Wendy’s well and have owned the stock in the past. The investment thesis is simple: the
company has too many company-operated stores, which are performing very poorly, and the company
has a bloated cost structure. Thus, the game plan is to cut costs and refranchise company-owned
restaurants – exactly what Peltz and his team did so successfully at Arby’s.

Wendy’s market cap is $2.2 billion and it has approximately $1 billion in debt (with covenants and
maturities that we are not concerned about), so that’s $3.2 billion of enterprise value. We estimate that
the combined company will have EBITDA of about $600 million, so today the stock being valued at
about 5.3x EBITDA. We think it’s worth closer to 8x.

Another way to look at Wendy’s valuation is to separate the high-margin franchise fee stream from both
Wendy’s and Arby’s from the low-margin restaurant operating business. We think the franchise fee
stream by itself is worth the enterprise value of the company, so you’re getting all of the restaurants for

Peltz, who is the largest shareholder of the company, certainly thinks Wendy’s is undervalued as he’s
been buying back stock not far below today’s price.

3) Winn-Dixie
Winn-Dixie operates 521 supermarkets, 70% in Florida and the rest in Alabama, Louisiana, Georgia and
Mississippi. Thanks to poor management, run-down stores and fierce competition, the company, which
had 1,000 stores at the time, filed for bankruptcy in early 2005. Having shed all of its debt and
approximately half of its stores, Winn-Dixie emerged from bankruptcy in late 2006 under the leadership
of Peter Lynch, who for the previous three years had been the President and COO of Albertsons, where
he’d been in charge of operations, merchandising and marketing for the company’s 2,500 stores. While
there, he had led a 200-store asset rationalization and $500 million expense reduction program.

During bankruptcy, Winn-Dixie shed its worst stores and is now investing in the remaining ones (it
plans to remodel 75 annually until all of its stores have been remodeled), with good results so far: in the
most recently reported quarter, gross margins rose, same-store comps at newly remodeled supermarkets
were +11.6% and overall same store sales were +3.0%.

Winn-Dixie’s stock is remarkably cheap in our view. It has a market capitalization of around $860
million, but an enterprise value of $700 million after netting out cash of $162 million (the company has
no debt, though it does have lease-related liabilities). That’s cheap for a company with more than $7.3
billion in revenues and projected EBITDA this year of $110-$125 million, even before factoring the
value of the company’s $550 million net operating loss carryforward from the bankruptcy.

Even if one counts lease liabilities as debt, Winn-Dixie’s enterprise value is a mere 12% of sales, which
is far below its peers as this chart shows:










Winn-Dixie Pantry SuperValu Kroger Weis Mkts Safeway Ruddick

Winn-Dixie has a much stronger balance sheet than these companies (all but Weis have 6-36x more debt
than cash), but Winn-Dixie trades at a far lower EV/S multiple due to its lower margins, as this chart

EBITDA margin









Winn-Dixie Pantry SuperValu Kroger Weis Mkts Safeway Ruddick

If we thought Winn-Dixie’s margins had no room for improvement, then we wouldn’t own the stock at
today’s price. However, we see no reason why, over the next couple of years, as Winn-Dixie continues
to remodel stores and grow sales, its EBITDA margin won’t double (at which point, it would still be
well below normal industry levels), which we believe will result in at least a doubling of the stock.

Eventually, we think Winn-Dixie will show sales and income growth to a point where it will be a nice
acquisition for a company seeking to expand in the rapidly growing southeast region. There are
probably three natural suitors.

For more on Winn-Dixie, see the excellent presentation by our friend Ken Shubin Stein of Spencer
Capital, which we included in the appendix of our November 2007 letter.

4) Huntsman
Huntsman is a chemical company that manufactures a wide range of specialty chemicals such as
polyurethanes and pigments. It is a market leader in nearly all its product categories.

Last year there was a bidding war for the company that was won with a bid of $28 a share by buy-out
firm Apollo, which intended to merge Huntsman into a company it controlled, Hexion Specialty
Chemicals. Then the markets and the financing world changed and Hexion tried to get out of the deal,
resulting in Huntsman’s stock collapsing and Huntsman suing Hexion, Apollo and its banks to force
them to consummate the deal.

Last month, Huntsman settled with Apollo, releasing them from consummating the deal, and, in return,
Apollo paid Huntsman $750 million in cash and agreed to buy $250 million in 10-year convertible notes
– a total of $1 billion in cash, which Huntsman has now received. We viewed this settlement as
favorable for Huntsman, but the stock was cut in half, falling below $3, upon the announcement. We
acquired the majority of our position at this time. We think the stock fell for three reasons:

A) Nobody wants to own a levered chemical company in this environment. We wouldn’t either, except
that the valuation is so compelling and there are no near-term maturities on the debt. Our research
indicates that demand for Huntsman’s products is very weak, but on the plus side, the price of the
company’s input costs (mainly energy) have fallen dramatically, which will help Huntsman’s operating
margin going forward.

B) Many arbs owned the stock, expecting (as we did) that the deal with Apollo would go through, albeit
at a lower price than originally agreed upon. When the deal fell through, the arbs – who were already
having an especially brutal year – sold indiscriminately. We always knew the deal might not happen
and were comfortable owning the underlying business at the price we paid.

C) Investors appear to be misunderstanding the dynamics of what’s happening vis-à-vis the litigation.
The key piece of information the market appears to be missing is that Apollo “agreed to fully cooperate
in connection with Huntsman’s litigation against” Credit Suisse and Deutsche Bank, which had
promised to fund the deal and then reneged. The suit, which “claims the banks conspired with Apollo
and tortiously interfered with Huntsman's prior merger agreement with Basell, as well as with the later
merger agreement with Hexion”, is going to court in May in Texas – not a jurisdiction where deep-
pocketed firms want to have this kind of case tried.

We think Huntsman has a strong case against the banks, especially now Apollo is co-operating, and
could win a big judgment or force the banks to pay a large amount to settle. Moreover, Apollo is highly
incentivized to be helpful, since it will receive 20% of any award over $500 million.

This is a fascinating situation for investors ready to do the research and comfortable with legal
complexities. It might sound a little bit off the beaten track for what we generally do, but Glenn’s
background is M&A, banking and LBOs.

5) Crosstex Energy
Crosstex is a midstream pipeline company structured as a master limited partnership (MLP), so there’s a
general partner (GP) (XTXI) and a limited partner (LP) (XTEX). We own both, weighted toward XTXI.
We’ve been following the company for years and have gotten to know the management and founders,
who we think are among the best in the business. Crosstex was formed by a firm called Yorktown
Partners, which is one of the most prestigious private equity firms in the energy space.

Like REITs, MLPs are required to pay out their cash flows, after debt service, to their owners. The
initial cash flow goes to the limited partners and, as cash flows grow, an increasing percentage of the
cash flow goes to the general partner. The objective of the LP is to pay big dividends, while the GP
seeks to grow the LP, primarily by making acquisitions, thereby increasing the revenue split to the GP
(XTXI owns 1/3 of the XTEX units/shares). Over time, an MLP typically raises equity capital and
mirrors it with debt capital to make acquisitions, which are accretive because the cost of equity plus the
cost of debt is less than the ultimate distributable cash flow, so each acquisition is slightly accretive to
the LP and highly accretive to the GP.

Crosstex gathers natural gas in the two primary shales in the country, the Barnett Shale and the
Hainesville Shale, and delivers it to the customers. These pipeline companies are primarily toll roads –
they get paid based on the volume of gas being delivered – but it’s not quite that simple. Crosstex
processes the natural gas at both ends, which introduces some profit variability. More importantly, in
some cases Crosstex takes delivery and has to hedge its exposure which, in our experience, is a net loss
game. As a result, Crosstex is levered to natural gas prices, which have collapsed, putting Crosstex’s
margins under pressure. This, combined with $1.1 billion of net debt (net of a recent $100 million asset
sale), has freaked out investors who fear that Crosstex will lose access to both debt and equity capital
forever, thereby impairing the company’s ability to grow and possibly even forcing a large cut in the

We think the leverage is manageable (there are only very small maturities in the next two years), the
company can maintain its dividend and that the financing markets will eventually return. Management
is making all of the right moves to deal with a very challenging environment, cutting back on cap ex and
expenses, conserving capital, selling excess assets and moving to a more conservative business plan.

We estimate that Crosstex’s run-rate EBITDA is $250 million this year so it’s levered 4.4x. There is a
debt covenant that starts ratcheting down in Q3 09, which has investors worried that Crosstex will need
to sell more assets – possibly a fire sale prices, given the current environment. In the event that
EBITDA falls to levels that necessitate further asset sales, we think the company will find many buyers
for its strategic assets, which are concentrated in the two most important natural gas shales in the
country. Also, XTEX’s EV/EBITDA is 5.4x, which is far beneath what any rational strategic buyer
would pay for assets like this, even in this environment. Assets like this almost never become available.
Even in a worst-case scenario in which the company must be sold, we think it would be at a significant

premium to today’s price. But we don’t think this scenario will come to pass, as Crosstex is nowhere
near a liquidity crisis.

At the beginning of 2008, XTXI was at $37.24 and was still above $30 as late as September, but then
rapidly declined to around $10, at which point we thought it was substantially undervalued (plus it was
yielding around 15%), so we began buying. Within weeks, it collapsed even further and hit a low of
$2.07 on December 15th, at which point, it was yielding 62%! This was very painful, but we re-did our
analysis and concluded that the share price decline below $10 was not primarily due to fundamental
factor but rather technical ones – the entire sector was getting crushed due, we believe, to hedge fund
liquidations/redemptions and year-end tax selling – so we added materially to our position.

The behavior of the stock in the past week is validating our belief that there was a great deal of forced
selling. On no news, the stock was up 51% on the last day of 2008 and has continued to skyrocket so far
this year, closing yesterday at $5.45, up 110% in the past five trading days.

Even after the stocks’ big surge over the past week, XTXI is yielding 23.5% and XTEX is yielding
31.0%. These yields imply that investors believe that Crosstex will soon cut or eliminate its dividends,
but both entities made their quarterly dividend distributions in early November, well after the stocks had
gone into freefall. Crosstex’s board and management are very rational. If they had any doubts about the
survival of the company, they would not have made these distributions.

6) dELiA*s
dELiA*s operates retail stores aimed at teenage girls and also owns and operates a successful direct
marketing business. We own nearly 10% of the company, which we think is one of the safest, cheapest
stocks we have seen in quite some time.

We started buying the stock in the second quarter of 2008 at around $2.00 per share, equal to an
enterprise value of about $55 million, based on our belief that its breakup value substantially exceeded
$4 per share. Our investment thesis began to play out in September, when the company announced the
sale of CCS, part of its direct marketing division, for $102 million in cash, or $3.28/share (pre-tax).
With the stock at $2.50, we expected it to skyrocket immediately, but instead it fell to a low of $1.65 and
closed the year at $2.20 due to some very motivated sellers and a general collapse in the market,
especially for the stocks of small retailers.

When dELiA*s reports Q4 earnings for the November through January period, we expect strong profits
and same-store sales, no debt and approximately $75 million in cash ($2.40/share), thanks to healthy
cash flow during the quarter and proceeds from the sale of CCS. With the stock currently at $2.25,
we’re not only getting one of the fastest growing specialty retailers in the country for free, but we’re
actually being paid to own it!

In light of the current environment, one might ask whether a retailer (especially one selling clothing to
teenage girls) is worth much, but dELiA*s is actually doing very well and we are very enthusiastic about
the company’s future. Same store sales were up 7.6% last quarter and margins are rising thanks in large
part to excellent new management. We’ve done a lot of research on them, from the CEO to the CFO to
the head merchant, and are very impressed. They are developing brands that are connecting with
dELiA*s target market and running a very tight operating ship.

Last month, we visited a dELiA*s store, met with management and saw their new line of products.
Management believes the company will have solid comps and positive free cash flow in the fourth
quarter and we think that’s likely right.

If the stock were to trade at one times sales, which would not at all be unusual, it would be at nearly $10
a share, plus the cash. That may sound pie-in-the-sky, but using other valuation metrics for rapidly
growing specialty retailers actually results in materially higher values. So, this is a stock at $2.25 that
could trade at $12 without making any Herculean assumptions.

This stock reminds us of a similar situation in late 2001 when we owned stock in TheStreet.com
(TSCM). In December of that year, it fell to $1 at a time when it had $1.43/share of cash, so it was
trading at the same 30% discount to cash that dELiA*s was only a few weeks ago. The difference is that
dELiA*s is profitable today whereas TheStreet.com in 2001 lost over $1/share and was rapidly burning
through its cash, so it wasn’t clear that the stock was a bargain. Nevertheless, it more than tripled in
only four months (and later hit $16), as this chart shows:

7) Wal-Mart
Wal-Mart was up 17.9% in 2008 – one of only two stocks in the Dow to rise (McDonald’s, which we
also own, was up 5.6% while the other 28 stocks all fell by double digits). Not much has changed since
we wrote about Wal-Mart in last year’s annual letter (and the letter before that and the letter before that):
it’s a solid, well-managed business with decent growth prospects. Amidst the economic stress of 2008,
shoppers flocked to Wal-Mart’s low prices and earnings grew nearly 10%.

With the stock trading at slightly under 15x 2009 earnings estimates, it’s only slightly undervalued but
we’re not inclined to sell our position because of the way we own it: through $50 strike five-year options
we bought about 3½ years ago. The options were written on very attractive terms to us and, with the
stock at the strike price (after this morning’s earnings warning), we like owning Wal-Mart this way.
Also, because the options are custom written, there’s a wide bid-ask spread if we were to try to sell
them. Note that most of this position is hedged out through call selling and shorting, but we are content
for now to hold the rest.

8) Fairfax and Odyssey Re

We’ve talked and written extensively about Canadian insurer Fairfax Financial (we also own one of its
subsidiaries, Odyssey Re (ORH)) and have included a copy of our latest slides on the company in
Appendix E. The stock held up well in 2008, rising 9.5%, while Odyssey Re jumped 41.1%.

Fairfax is a controversial company that has been at the center of a nasty tug-of-war between the
company and short-sellers. We rarely get involved in such messy situations, but did in this case because
we believe we’re getting a diverse collection of high-quality insurance businesses at a discount to
intrinsic value, plus a free call option on Fairfax and Odyssey Re’s credit-default swap (CDS) portfolios.

Fairfax’s three major insurance subsidiaries (one of which is Odyssey Re) are doing well: they grew 19-
22% annually from 2001-2007, their return on equity (ROE) in 2007 ranged from 23%-26%, and their
combined ratios fell from 109.4 in 2005 to 95.5 in 2006 to 94.0 in 2007, driving a 32.3% gain in
underwriting profit in 2007.

As for CDSs, Fairfax has been trimming its portfolio and has harvested, in cash, well over $2 billion of
gains, earning a roughly 10x profit in less than two years. As of October 24th, Fairfax continued to own
$9.8 billion notional amount of CDSs, valued at $596 million, on numerous financial companies
including AIG, Fannie Mae, Freddie Mac, Bank of America, MGIC, PMI Group, Radian, Washington
Mutual, Societe Generale and XL Capital (Odyssey owns a similar portfolio). It would be hard to
construct better portfolios of companies with exposure to the mortgage and credit crises. We keep
thinking the gains from the CDSs are coming to an end, but given the market chaos in November and
December, Fairfax might have realized substantial additional profits since Oct. 24th.

Both companies reported third quarter earnings on October 30th and their performance was everything
we hoped for and more. Fairfax earned over $25 per share during the quarter while Odyssey earned
almost $2 per share. In addition to strong earnings, both companies reported increased cash, reduced
debt, better than expected underwriting results (even with hurricane Gustav) and further credit-default
swap gains (both unrealized and monetized).

With Fairfax’s stock around $313, it trades at 1.2x tangible book value. We think its core business is
worth 1.3-1.5x book value, so at today’s price, the stock does not fully reflect this value, plus we’re
getting a free call option on Fairfax’s CDS portfolio, which could be worth a great deal more. Fairfax
shares our view that its shares are cheap and is aggressively buying back its stock. Using the same

valuation metrics, Odyssey Re’s stock is comparably cheap.

9) EchoStar Corp.
At the beginning of 2008, satellite TV company EchoStar Communications split into two: Dish Network
(DISH) and EchoStar Corp. (SATS), which is a collection of satellites, set-top box businesses and a
number of investments, cash and marketable securities, all managed by legendary founder Charles
Ergen. Our slides on this company are in Appendix F.

Subscribers to the Dish Network install a dish, pay a monthly fee of approximately $30 and receive lots
of television channels. In 2006 there was a strong expectation that Dish Network was going to merge
with one of the telcos so, in preparation for that, EchoStar Corp. was formed and received all of the
assets that a telco would not want to buy, thereby making Dish Network a more attractive acquisition.

SATS has the typical spin-off dynamics: it’s smaller than the original company, had a relatively
unnatural initial shareholder base that sold the stock, and management has tended to sandbag the
expectations for the company so that their options are struck at a low price.

At today’s stock price, the company is being valued at its cash and investment securities, meaning an
investor is paying nothing for the company’s businesses, technology and investments. This includes
eight satellites (six owned and two leased, with an original cost of $1.6 billion), a high value, hard-to-
replace asset.

It also includes a set-top box manufacturing business – these are the boxes that Dish Network buys –
with $1.7 billion in trailing 12-month revenue. In a normal income statement environment, that revenue
stream would probably be worth $2-3 billion, but the boxes are sold on a cost-plus basis to DISH, so
until DISH is acquired or SATS starts selling these boxes to other customers, that business is not worth a
lot today – but it has a tremendous amount of potential value.

We think SATS will start selling to other customers because it has other technologies to make better
boxes. When SATS was a wholly owned subsidiary of Dish Network, no one other than Dish would
buy the boxes because Dish was as competitor. Now that SATS is an independent company, we expect
it will have eventually have success selling boxes to other companies.

Finally, SATS has some other interesting technologies such as Sling Media.

In summary, we think SATS is hugely undervalued, but there are no natural buyers. As a spin-off, it
was likely heavily owned by hedge funds and, given that the stock was down 54% in 2008, many were
likely dumping it. There’s a big margin of safety since the company can be liquidated for more than it’s
trading for.

10) Distressed debt (tranche of a subprime RMBS)

Given how bearish we are on the unfolding mortgage crisis, you might be surprised to learn that we
purchased part of a tranche of a pool of 2006-vintage subprime mortgages. We haven’t suddenly
become bullish – far from it. Rather, the price was so low that, even in an Armageddon scenario, we
think we’ll make cash returns of 50-100% annually in the next two years.

The slides in Appendix G provide the details. They’re mostly self-explanatory, but here are a few

The first three slides have background information on the pool, which is a typical bubble-era
pool of subprime mortgages (an RMBS – residential mortgage-backed security).

The fourth slide shows where the tranche we purchased (the IIA2) is in the capital structure of
the RMBS. It’s very senior, junior only to the IIA1 tranche, which is already 78% paid off.

Slides 5-7 show the catastrophic performance of this pool in the 26 months since inception.
49.5% of the loans have already defaulted and 5% of the performing loans are defaulting every

The final slide shows our expected return (in the third column) based on certain fixed
assumptions and one variable assumption: the severity (i.e., losses taken) of mortgages in the
pool that have already defaulted but where the home has not yet been sold. Note that we’re not
assuming anything gets better due to, for example, a stabilization of home prices or a homeowner
relief bill passed by Congress. In fact, we assume things get worse, yet still project an IRR of
50-100% on this investment.

Berkshire Hathaway: A High-Quality, Rapidly
Growing 70-Cent Dollar

• Berkshire Hathaway today does not resemble the company that
Buffett bought into during the 1960s
• Berkshire was a leading New England-based textile company, with
investment appeal as a classic Ben Graham-style “net-net”
• Buffett took control of Berkshire on May 10, 1965
• At that time, Berkshire had a market value of about $18 million and
shareholder's equity of about $22 million

Appendix C: Berkshire Hathaway

The Berkshire Hathaway Empire Today

Stakes in Public
Companies Worth $1B+
Company Shares Price Value ($B)
Coca-Cola 200.0 $44.89 $9.0
Wells Fargo 290.4 $26.72 $7.8
Procter & Gamble 105.8 $61.41 $6.5
Burlington Northern 63.8 $79.60 $5.1
Conoco Phillips 84.0 $53.91 $4.5
Kraft 138.3 $27.81 $3.8
Johnson & Johnson 61.8 $59.44 $3.7
American Express 151.6 $20.53 $3.1
U.S. Bancorp 72.9 $23.74 $1.7
Wal-Mart 19.9 $55.91 $1.1
Moody's 48.0 $22.89 $1.1

Note: Stock prices as of 1/7/09

The Basics

• Stock price (12/31/08): $96,600

– $3,214 for B shares
• Shares outstanding: 1.55 million
• Market cap: $150 billion
• Total assets (Q3 ‘08): $282 billion
• Total equity (Q3 ‘08): $120 billion ($111 billion of as of the end
of October)
• Book value per share (Q3 ‘08): $77,519

Recent Performance of Key Business Units
By Year:

2004 2005 2006 2007

Insurance Group:
Premiums Earned
GEICO 970 1,221 1,314 1,113
General Re 3 -334 523 555
Berkshire Reinsurance Group 417 -1,069 1,658 1,427
Berkshire H. Primary Group 161 235 340 279
Investment Income 2,824 3,480 4,316 4,758
Total Insurance Oper. Inc. 4,375 3,533 8,151 8,132

Non-Insurance Businesses:
Finance and Financial products 584 822 1,157 1,006
McLane Company 228 217 229 232
Shaw Industries 466 485 594 436
MidAmerican/Utilities/Energy 237 523 1,476 1,774
Other businesses 1,787 1,921 2,703 3,279
Total Non-Insur. Oper. Inc. 3,302 3,968 6,159 6,727

Total Operating Income 7,677 7,501 14,310 14,859

Recent Performance of Key Business Units
By Quarter:

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
Insurance Group: 2005 2005 2005 2005 2006 2006 2006 2006 2007 2007 2007 2007 2008 2008 2008
Premiums Earned
GEICO 312 358 237 314 311 288 407 308 295 325 335 158 186 298 246
General Re 19 43 -389 -7 71 106 177 169 30 230 157 138 42 102 54
Berkshire Reinsurance Group 143 140 -1,635 283 94 137 735 692 553 356 183 335 29 79 -166
Berkshire H. Primary Group 18 37 -10 190 35 43 108 154 49 63 77 90 25 81 -8
Investment Income 787 851 900 942 1,018 1,102 1,103 1,093 1,078 1,236 1,217 1,227 1,089 1,204 1,074
Total Insurance Oper. Inc. 1,279 1,429 -897 1,722 1,529 1,676 2,530 2,416 2,005 2,210 1,969 1,948 1,371 1,764 1,200

Non-Insurance Businesses:
Finance and Financial products 199 199 207 217 251 343 282 281 242 277 273 214 241 254 163
Marmon 28 261 247
McLane Company 69 59 53 36 55 56 50 68 58 72 50 52 73 68 68
MidAmerican/Utilities/Energy 141 100 141 141 418 278 416 364 513 372 481 408 516 329 526
Shaw Industries 88 139 145 113 155 169 138 132 91 111 125 109 51 82 49
Other businesses 364 514 486 557 430 671 686 916 632 904 895 848 721 874 749
Total Non-Insur. Oper. Inc. 861 1,011 1,032 1,064 1,309 1,517 1,572 1,761 1,536 1,736 1,824 1,631 1,630 1,868 1,802

Total Operating Income 2,140 2,440 135 2,786 2,838 3,193 4,102 4,177 3,541 3,946 3,793 3,579 3,001 3,632 3,002

The Earnings of Berkshire’s Operating Businesses Have
Grown at a Very High Rate – And Growth is Accelerating

Per-Share Per-Share
Year Investments CAGR Pre-Tax Earnings CAGR
1965 $4 $4
1979 $577 42.8% $18 11.1%
1993 $13,961 25.6% $212 19.1%
2007 $90,343 14.3% $4,093 23.5%

Berkshire is becoming less of an investment

company and more of an operating business.

Note: CAGR: 1965-1979, 1979-1993, 1993-2007. EPS is pretax and net of minority interests.

Growth in Earnings of Berkshire’s Operating Businesses Has Slowed
as Buffett Has Allocated More Capital to Investments in Recent Years
% Growth
Company Name Market Cap Rate*
Exxon Mobil $408,458 24
Wal-Mart $219,741 10
Procter & Gamble $185,621 14
Microsoft $184,672 18
* 5-year
General Electric $177,404 8 compound annual
AT&T $166,772 26 growth rate of
Johnson & Johnson $165,614 9
Chevron $157,159 27
EBIT (earnings
Berkshire Hathaway $154,573 14 before interest
Pfizer $120,024 6 and taxes)
IBM $119,877 9
Cisco Systems $104,162 13
through Q3 07.
Coca-Cola $103,439 9 Berkshire’s figure
Google $102,180 n/a is pre-tax EPS
Hewlett-Packard $94,981 22
excluding all
Oracle $92,799 19
Verizon $90,782 3 income from
Genentech $88,371 48 investments.
Pepsico $86,509 11
Intel $85,488 11
ConocoPhillips $83,009 28
Apple $82,689 202
Note: List of 25 largest companies (by
market cap) that trades on U.S. Abbott Labs $79,007 9
exchanges McDonald's $69,258 16
Source: Capital IQ, through 1/6/09 Amgen $61,813 14
Median -28- 14
Buffett Is Putting Berkshire’s Money to Work Rapidly –
And Increasingly in Stock Purchases
We estimate that Berkshire made more than $50 billion in commitments in 2008, only
a fraction of which appears on the cash flow statement through Q3

(2) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1-3

Acquisitions Net Stock Purchases

• He’s doing a good job – but the cash is coming in so fast!

– A high-class problem
• Markets have a way of presenting big opportunities on short notice
– Current chaos, junk bonds in 2002
– Buffett has reduced average maturity of bond portfolio so he can act
A Breakdown of Berkshire’s Capital Commitments in 2008

Investment/Commitment $(B) Comment

General stock purchases $7.4 Through Q3; net of sales
Mars/Wrigley $6.5
Auction rate securities $6.5 Q2 event; sold much in Q3
Goldman Sachs $5.0 Plus $5B to exercise warrants
Constellation Energy $4.7
Marmon $4.5 More to come
Dow/Rohm & Haas $3.0
General Electric $3.0 Plus $3B to exercise warrants
Fed. Home Loan Disc. Notes $2.4 Q2 event; sold much in Q3
Constellation Preferred $1.0
Tungaloy $1.0 Iscar acquisition
Swiss Re unit $0.8 Plus sharing agreement
ING reinsurance unit $0.4
TOTAL $46.2 Plus $8B to exercise warrants

Note: Does not include capital committed to Berkshire’s new bond insurance business, Berkshire Assurance
Valuing Berkshire
“Over the years we've…attempt[ed] to increase our marketable investments in
wonderful businesses, while simultaneously trying to buy similar businesses in their
entirety.” – 1995 Annual Letter

“In our last two annual reports, we furnished you a table that Charlie and I believe is
central to estimating Berkshire's intrinsic value. In the updated version of that table,
which follows, we trace our two key components of value. The first column lists our
per-share ownership of investments (including cash and equivalents) and the second
column shows our per-share earnings from Berkshire's operating businesses before
taxes and purchase-accounting adjustments, but after all interest and corporate
expenses. The second column excludes all dividends, interest and capital gains that
we realized from the investments presented in the first column.” – 1997 Annual Letter

“In effect, the columns show what Berkshire would look like were it split into two parts,
with one entity holding our investments and the other operating all of our businesses and
bearing all corporate costs.” – 1997 Annual Letter
Buffett’s Comments on Berkshire’s Valuation Lead
to an Implied Multiplier of Approximately 12
Pre-tax EPS
Excluding All Year-End
Investments Income From Stock Intrinsic Implied
Year Per Share Investments Price Value Multiplier
1996 $28,500 $421 $34,100 $34,100 13
1997 $38,043 $718 $46,000 $46,000 11
1998 $47,647 $474 $70,000 $54,000 13
1999 $47,339 -$458 $56,100 $60,000

• 1996 Annual Letter: “Today's price/value relationship is both much different from what
it was a year ago and, as Charlie and I see it, more appropriate.”
• 1997 Annual Letter: “Berkshire's intrinsic value grew at nearly the same pace as book
value” (book +34.1%)
• 1998 Annual Letter: “Though Berkshire's intrinsic value grew very substantially in
1998, the gain fell well short of the 48.3% recorded for book value.” (Assume a 15-
20% increase in intrinsic value.)
• 1999 Annual Letter: “A repurchase of, say, 2% of a company's shares at a 25%
discount from per-share intrinsic value...We will not repurchase shares unless we
believe Berkshire stock is selling well below intrinsic value, conservatively
calculated...Recently, when the A shares fell below $45,000, we considered making

Applying the 12 Multiple: 2001 – 2008
Pre-tax EPS
Excluding All Intrinsic Subsequent
Investments Income From Value Year Stock
Year End Per Share Investments1 Per Share Price Range
2001 $47,460 -$1,289 $64,000 $59,600-$78,500
2002 $52,507 $1,479 $70,000 $60,600-$84,700
2003 $62,273 $2,912 $97,000 $81,000-$95,700
2004 $66,967 $3,003 $103,000 $78,800-$92,000
2005 $74,129 $3,600 $117,300 $85,700-$114,200
2006 $80,636 $5,200-$5,400 $143,000-$144,400 $107,200-$151,650
2007 $90,343 $5,500-$5,700 $156,300-$158,700 $84,000-$147,000
4 5
2008 $76,000 $5,000 $136,000 ?
1. Unlike the table on page 4 of the 2007 Annual Report, we include earnings from Berkshire’s
insurance businesses.
2. Actual result was $6,492, but we reduce this to assume the 2nd-worst year ever for super-cat losses.
3. Actual result was $6,270 but we reduce the pre-tax, pre-investment-income margins of the insurance
businesses by 400 basis points (from 14% to 10%) to reflect Buffett’s guidance in the Annual
4. Investments per share was $86,000 as of Q3, but we estimate a $10,000/share impact due to market
declines in Q4.
5. We have trimmed our estimate of normalized earnings to reflect the weak economy.
Berkshire Is Approximately 30% Below Intrinsic Value,
Near the Most Undervalued It’s Been in the Past 12 Years
Intrinsic value estimate of
$136,000, which doesn’t factor
in $50+ billion of investments
& commitments in 2008

Intrinsic value*
30% discount to
intrinsic value

* Investments per share plus 12x pre-tax earnings per share (excluding all income from investments) for the prior year.
Valuation Approach #2: Pro-Forma Earnings

• Market cap: $150B

• 2007 company earnings: approximately $11.5B
– adjusted for normal super-cat losses and pricing, and for
unusually high capital gains in 2007
• Plus 2007 estimated look-through after-tax earnings after cash
distributions: $2.2B
• Equals total pro-forma earnings of $13.7B
• P/E: $150B / $13.7B = 10.9x

12-Month Investment Return

• Current intrinsic value: $136,000/share

• Plus 10% growth of intrinsic value of the business
• Plus cash build over next 12 months: $5,000/share
• Equals intrinsic value in one year of $154,600
• 60% above today’s price


• Continued earnings growth of operating businesses

• New equity investments
• Additional cash build
• Potential for more meaningful acquisitions and investments
– If the credit crunch continues or worsens, this becomes more


• Current recession impacts earnings more than expected

• Recent investments turn out badly
• No catalysts
– Intrinsic value will likely continue to grow nicely
• Buffett’s health
– In good health; turned 78 last Aug. 30th
– Strong board and succession plan in place
– Little Buffett premium in stock today
• Major super-cats
• Can’t find place to invest cash
– Not a problem currently
– There are worse things than sitting on a lot of cash
– Buffett has said Berkshire will distribute cash if he
doesn’t think he can allocate it


• Cheap stock: 70-cent dollar, giving no value to recent

investments and immense optionality
• Extremely safe: huge cash and other assets provide downside

Appendix D: Berkshire Hathaway Credit
Risk, Index Puts Are Overblown Worries
By Whitney Tilson, T2 Partners LLC, November 20, 2008 (WTilson@T2PartnersLLC.com)


I’ve seen a lot of crazy things in my investment career, but I struggle to think of anything that
tops this: Berkshire Hathaway’s five-year credit-default swap spreads have more than tripled in
the past two months and now stand at 475 basis points (CDS quotes in this article are as of the
end of day 11/19/08 and stock quotes as of 11/20/08), as this chart indicates:

To get some perspective on what this means, the median CDS spread for companies with the
lowest investment grade bond rating (BBB-) is 348 basis points, according to Moody’s, so the
CDS market is indicating that AAA-rated Berkshire is junk! Or consider this chart, which shows
that Berkshire’s CDSs are higher than a wide range of other financial companies (more than 4x
Travelers, 3x JP Morgan Chase and well above Citigroup, even after Thursday’s stock collapse –
the world has truly gone mad!):












A final thought on how crazy Berkshire’s CDS spreads are: what are investors who are buying
CDSs on Berkshire thinking regarding counterparty risk? If things get so bad that AAA-rated
Berkshire Hathaway goes bankrupt and defaults on its debt, what counterparty is likely to still be
standing to pay on the CDSs???

Why Are Investors Panicked About Berkshire?

Investors appear to be spooked by the widening CDS spreads, causing the stock to tumble to a
low today of $74,100, down 37% in the past two weeks to its lowest level in more than five
years. Berkshire is among our largest positions, so the decline has been painful, but we’re
delighted to have the opportunity to add to our largest investment at such attractive prices, and
have been doing so aggressively.

Beyond the ever-present worries about Buffett’s age (he gets one day older every day –
SURPRISE!) and the dreadful economy, the market’s recent concerns appear to revolve around
the Q3 earnings report, which was released on November 7th (the stock has declined every day
since then), and derivative contracts that Buffett wrote mostly last year. Let’s address them in

Q3 Earnings

The headline was that Berkshire’s net earnings fell 77% in Q3, but this was mostly due to $1.3
billion on noncash “losses” on derivative contacts (discussed further below). Berkshire’s after-
tax operating earnings declined 19.2% year-over-year during the quarter, but were still a

remarkable $2.1 billion, a respectable performance in light of the weak economy and two major
hurricanes, Gustav and Ike, which led Berkshire to book significant super cat losses that reduced
insurance underwriting profits from $486 million in Q3 07 to $81 million in Q3 08. Berkshire’s
non-insurance businesses had operating earnings of $1.18 billion, up 2.3% (that’s not a typo),
thanks in part to the Marmon acquisition.

In summary, Berkshire’s operating businesses are weathering the downturn well, remain
enormously profitable and generate huge amounts of cash. In addition, thanks to committing
more than $50 billion to new investments this year, money that had previously been in cash and
low-yielding bonds, Berkshire’s cash generating power will increase substantially in the future.

Derivative Contracts

If one does no analysis, Berkshire’s derivative contracts appear to pose similar risks to those that
caused AIG and others to collapse, but in reality, nothing could be further from the truth.

There is no mystery about these contracts (or at least there shouldn’t be), as Buffett has provided
a great deal of disclosure. Here is the relevant excerpt from his 2007 annual letter
(www.berkshirehathaway.com/letters/2007ltr.pdf, page 16):

Last year I told you that Berkshire had 62 derivative contracts that I manage. (We also have a few left in
the General Re runoff book.) Today, we have 94 of these, and they fall into two categories.

First, we have written 54 contracts that require us to make payments if certain bonds that are included in
various high-yield indices default. These contracts expire at various times from 2009 to 2013. At yearend
we had received $3.2 billion in premiums on these contracts; had paid $472 million in losses; and in the
worst case (though it is extremely unlikely to occur) could be required to pay an additional $4.7 billion.

We are certain to make many more payments. But I believe that on premium revenues alone, these
contracts will prove profitable, leaving aside what we can earn on the large sums we hold. Our yearend
liability for this exposure was recorded at $1.8 billion and is included in “Derivative Contract Liabilities”
on our balance sheet.

The second category of contracts involves various put options we have sold on four stock indices (the S&P
500 plus three foreign indices). These puts had original terms of either 15 or 20 years and were struck at the
market. We have received premiums of $4.5 billion, and we recorded a liability at yearend of $4.6 billion.
The puts in these contracts are exercisable only at their expiration dates, which occur between 2019 and
2027, and Berkshire will then need to make a payment only if the index in question is quoted at a level
below that existing on the day that the put was written. Again, I believe these contracts, in aggregate, will
be profitable and that we will, in addition, receive substantial income from our investment of the premiums
we hold during the 15- or 20-year period.

Two aspects of our derivative contracts are particularly important. First, in all cases we hold the money,
which means that we have no counterparty risk.

Second, accounting rules for our derivative contracts differ from those applying to our investment portfolio.
In that portfolio, changes in value are applied to the net worth shown on Berkshire’s balance sheet, but do
not affect earnings unless we sell (or write down) a holding. Changes in the value of a derivative contract,
however, must be applied each quarter to earnings.

Thus, our derivative positions will sometimes cause large swings in reported earnings, even though Charlie
and I might believe the intrinsic value of these positions has changed little. He and I will not be bothered by

these swings – even though they could easily amount to $1 billion or more in a quarter – and we hope you
won’t be either. You will recall that in our catastrophe insurance business, we are always ready to trade
increased volatility in reported earnings in the short run for greater gains in net worth in the long run. That
is our philosophy in derivatives as well.

Buffett elaborated on this in the Q3 earnings release:

During the first nine months, Berkshire’s derivatives had an unrealized pre-tax loss of $2.21 billion.
However, that is a figure incorporating gains and losses in several different kinds of derivatives.
Fundamentally, the size of that figure reflects the fact that we recorded a $2.06 billion unrealized loss in
our two major categories of derivatives. This represents an increase in our loss during the third quarter of
$1.05 billion from the loss of $1.01 billion we recorded during the first six months.

At the end of the third quarter, we had a liability of $6.72 billion for equity index put option contracts for
which we have received cash payments of $4.85 billion. This means our recorded loss to date is $1.87
billion though the first payment that could be triggered would be in 2019, and the average maturity is 13.5
years. In the meantime all of the $4.85 billion can be invested by Berkshire.

Finally, here is the table on Berkshire derivative contracts from the Q3 10-Q:

Note 5. Derivative contracts of finance and financial products businesses

Berkshire utilizes derivative contracts in order to manage certain economic business risks as well as to
assume specified amounts of market risk from others. The contracts summarized in the following table,
with limited exceptions, are not designated as hedges for financial reporting purposes. Changes in the fair
values of derivative assets and derivative liabilities that do not qualify as hedges are reported in the
Consolidated Statements of Earnings as derivative gains/losses. Master netting agreements are utilized to
manage counterparty credit risk, where gains and losses are netted across other contracts with that

Under certain circumstances, including a downgrade of its credit rating below specified levels, Berkshire
may be required to post collateral against derivative contract liabilities. However, Berkshire is not required
to post collateral with respect to most of its credit default and equity index put option contracts and at
September 30, 2008 and December 31, 2007, Berkshire had posted no collateral with counterparties as
security on these contracts.

A summary of the fair value and gross notional value of open derivative contracts of finance and financial
products businesses follows. Amounts are in millions.

So what does all of this mean? Simply put, Buffett has sold long-dated insurance against the
debt of specific companies (credit default obligations or CDSs, expiring between 2009 and 2013)
and against declines in the world’s major stock market indices (equity index put options, with the
first expiration in 2019 and average maturity of 13.5 years).

When evaluating these investments, there are two considerations: will they be ultimately be
profitable (which won’t be known for another 19 years in some cases) and are there triggers that
could cause a short-term liquidity crunch for Berkshire? In short, we believe the answers are
almost certainly yes and absolutely not, respectively.

Since Buffett wrote these contracts, CDS spreads have widened and the world’s major stock
market indices have fallen precipitously, such that Berkshire booked unrealized pretax losses of
$2.2 billion in the first three quarters of this year. Given what the markets have done since
September 30th, there could be an additional $1-2 billion in mark-to-market, noncash losses so
far this quarter.

So writing these derivative contracts was a horrible idea, right? Not so fast…

Were the CDS Contracts Good Investments?

Regarding the CDS contracts, we don’t know which companies Buffett wrote CDSs on, nor what
he was paid, but it doesn’t appear that the counterparties can exercise the CDSs and demand cash
based on current prices – rather, Berkshire has to pay only in the event of an actual default.
Here’s the relevant excerpt from Buffett’s 2007 annual letter:

…we have written 54 contracts that require us to make payments if certain bonds that are included in
various high-yield indices default. These contracts expire at various times from 2009 to 2013. At yearend
we had received $3.2 billion in premiums on these contracts; had paid $472 million in losses; and in the
worst case (though it is extremely unlikely to occur) could be required to pay an additional $4.7 billion.

We are certain to make many more payments. But I believe that on premium revenues alone, these
contracts will prove profitable, leaving aside what we can earn on the large sums we hold.

So far this year, Buffett has written more of these contracts, bringing the notional value (i.e.,
maximum loss) from $4.7 billion to $10.8 billion (as of the end of Q3, according to the table
from the 10-Q, above).

If these contracts were written by anyone else, I would be worried about substantial losses over
the next few years, but given what I know about Buffett, I think it’s likely that this will prove to
be a profitable investment.

Were the Equity Index Put Option Contracts Good Investments?

But what about the much larger equity index put option contracts, for which Berkshire was paid
$4.85 billion and had suffered noncash “losses” of $1.9 billion through Q3? Surely this was a
huge mistake, right? Again, not so fast…

Buffett sold at-the-money puts on the four major world market indices at various times over the
past few years – we don’t know at what level, but let’s assume the worst cases that these indices
are down by 40% on average from their strike prices. If the indices rebound by 67% over the
next 13.5 years (the average remaining duration of the puts), a mere 3.9% annually, then the puts
will expire worthless and Buffett can pocket the entire $4.85 billion.

Berkshire’s maximum exposure is $37.0 billion, presumably if the four indices all fall to zero,
but this isn’t going to happen so let’s look at more likely scenarios. We don’t know the details of
how the puts are structured, but let’s assume the payouts are on a straight-line basis, such that if
the indices are down 50% 13.5 years from now – another 17% from today’s levels – then
Berkshire will have to pay $18.5 billion (half of the $37 billion maximum). That would be a
painful loss, to be sure, but one that Berkshire could easily afford: the company’s earning power
today exceeds $10 billion per year and, as of the end of October, its net worth exceeded $111
billion, both figures that will be much higher more than a decade from now.

It’s also important to understand that the loss in this doomsday scenario would not be $18.5
billion minus $4.85 billion because Buffett can invest the $4.85 billion for the entire period. If
he earns a mere 7% return for 13.5 years, $4.85 billion becomes $12.1 billion (at a more likely
10% annually, it would be $17.6 billion). If we assume a 7% compounded return, Berkshire’s
break-even point on this investment would be a 33% decline in the indices from the point at
which the puts were written, meaning the indices would only have to increase less than 1%
annually over the next 13.5 years to reach this from today’s level of down 40%.

I think it’s very likely that the indices will compound at 4% annually from today’s depressed
levels, making it unlikely that Berkshire will have to pay out anything on these contracts. And
given how much Buffett was paid to write them and his ability to invest the premium he was paid
in any way he chooses, it’s even more unlikely that this will be a losing investment. Thus, even
knowing what I know today, I think this was a fantastic investment and wish Buffett had written
more of these contracts (perhaps he’s writing more today?).

Liquidity Concerns?

It is critically important to understand that the derivative contracts Buffett sold cannot be
exercised prior to expiration, nor does Berkshire have to post collateral when the CDS spreads
widen and/or the indices fall. Thus, the company has virtually no liquidity risk.

So why do investors appear to have this concern? Most likely, they simply haven’t done their
homework, or perhaps they are misunderstanding this disclosure in Berkshire’s Q3 10-Q:

Under certain circumstances, including a downgrade of its credit rating below specified levels, Berkshire
may be required to post collateral against derivative contract liabilities. However, Berkshire is not required
to post collateral with respect to most of its credit default and equity index put option contracts and at
September 30, 2008 and December 31, 2007, Berkshire had posted no collateral with counterparties as
security on these contracts.

I doubt Buffett would write any contracts that would require Berkshire to post collateral in the
event of a downgrade, so I suspect that this disclosure relates to some of the legacy derivative
contracts that Berkshire inherited when it acquired Gen Re. Buffett wisely shut down Gen Re’s
derivatives business many years ago, however, and there are very few contracts remaining, so the
risk here is immaterial.

Today, Berkshire spokesperson Jackie Wilson confirmed to Reuters that the company has
“nominal” collateral requirements that would take effect were credit rating agencies to reconsider

its triple-A rating, and said that collateral requirements would total “far below 1 percent of
assets”. Assets were $282 billion as of Q3, so we now know that Berkshire’s total collateral
requirements, in a worst-case scenario, are “far below” $2.8 billion.

Berkshire does have to book unrealized gains or losses every quarter on its derivative contracts
(unlike changes in value in its much larger marketable securities portfolio), but these are noncash
changes, as Buffett explained in the Q3 earnings release:

With very limited exceptions, gains or losses from marketable securities are recorded only upon sale.
Berkshire has large amounts of unrealized gains, and sales are never made with an eye to their effect on
reported earnings. During the first nine months of 2008, our unrealized gains fell by $7.5 billion (leaving us
a total of $24.3 billion in unrealized gains at the end of September). That decline of $7.5 billion does not
show in our reported earnings. What is included is a realized gain: $65 million pre-tax and $42 million

In contrast, accounting rules require that any unrealized gain or loss from most of our derivative contracts
be regularly recorded in earnings.

A final risk factor to consider is undisclosed risks – the type that have blindsided investors in so
many other financial companies. It’s impossible to rule out unexpected surprises for any
company, but anyone who’s studied Buffett will surely take comfort in his 50+ years of
conservatism and openness with his investors.

To understand why it’s so unlikely that there might be hidden derivative bombs on Berkshire’s
balance sheet, one needs to understand how Buffett thinks about risks like this. For example,
here’s an excerpt from his 2002 annual report (page 14), in which he warns about the exact
scenario that crushed AIG this year:

Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for
completely unrelated reasons. This pile-on effect occurs because many derivatives contracts require that a
company suffering a credit downgrade immediately supply collateral to counterparties. Imagine, then, that
a company is downgraded because of general adversity and that its derivatives instantly kick in with their
requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need
to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still
more downgrades. It all becomes a spiral that can lead to a corporate meltdown.


At $77,500, Berkshire’s stock today is the cheapest, by far, we have ever seen it, going back at
least a dozen years.

We estimate Berkshire’s valuation the same way Buffett does: we value the investment per share
(cash, bonds and stocks) at market and then place a 12 multiple on the pre-tax operating profits
of the company (for more details on this as well as our entire analysis of Berkshire, see our
presentation, which is posted here). As of the end of last year, investments per share were
$90,343 and our estimate of normalized pretax earnings was $5,500-$5,700/share, which resulted
in an estimate of intrinsic value of $156,300-$158,700.

As of the end of the third quarter, investments per share had fallen to $86,000 due to declines in
the prices of stocks Berkshire holds as well as Buffett investing tens of billions of cash in a wide
range of operating businesses. In light of the severe market decline in October and so far in
November plus additional investments Buffett has made, we estimate that investments per share
might have fallen to as low as $76,000.

As for Berkshire’s earnings, they are obviously impacted by the weak economy, but this is offset
by the many new businesses Buffett has purchased. Over time, the many investments and
acquisitions Buffett’s made this year will lead to much higher earnings, but for the next 12
months, to be conservative, let’s assume that pretax earnings are $5,000/share (assuming the
severe recession continues and a normal super cat year). This results in an estimate of intrinsic
value of $136,000, 76% above today’s level.

This slide from our presentation (posted here, page 12) shows Berkshire’s share price over the
past 12 years, with each year’s estimate of intrinsic value:

One can see that Berkshire’s share price has, at some point during every year, reached intrinsic
value except for 2005 and so far this year. One can also see how far below intrinsic value
Berkshire is today.

Another way to think about Berkshire’s value is to consider that Berkshire’s share price today
barely exceeds investments. Thus, today one can own the collection of fabulous businesses that
Buffett has acquired over the years pretty much for free.

In this environment, it’s not surprising to us that the stocks of companies with shaky balance
sheets, poor business models and/or weak competitive positions are getting clobbered, but
Berkshire’s freefall in the past few weeks is certifiably crazy – and a buying opportunity that will
long be remembered.

Disclosure: Funds the author manages are long Berkshire Hathaway

Fairfax Is a Diversified Insurance Holding Company

Appendix E: Fairfax Financial

Fairfax Since 2006

Fairfax Has an Extraordinary Long-Term
Track Record of Value Creation

Fairfax and Its Primary Subsidiaries Had a Great 2007 and Growth
and Underwriting Trends Have Been Strong for Many Years

1. Crum and Forster 6 month 2008 results include 20.6 points related to a reinsurance commutation and a reinsurance settlement.
Source: Fairfax presentation, 9/08
Fairfax Has Made Enormous Strides Over the Past Year

Fairfax’s Financial Strength Has Improved Dramatically

Source: Fairfax presentation, 9/08

Fairfax’s CDS Portfolio Has Paid Off In a Big Way – And We
Think There’s More Upside As the Credit Crunch Worsens

As of 10/24/08, Fairfax had

harvested $2.05 billion in cash
from its CDS portfolio since
mid-2007, representing gains
of $1.81 billion. It had $9.8
billion notional amount of credit
default swaps, valued at
$596M remaining. Its 23 CDS
positions include (in
descending order): AIG,
Societe Generale, Fannie
Mae, Freddie Mac, XL Capital,
Barclays, Goldman Sachs,
Genworth, MGIC, ACE,
Washington Mutual, Swiss Re,
Bank of America and PMI.

Hamblin Watsa’s Investment Performance
Has Been Spectacular

Fairfax Is Trading At a Low Multiple of Book Value,
Even If the Entire CDS Portfolio is Excluded
• Price (12/31/08): $313.41
• Market cap: $5.48 billion
• Tangible book value (Q3 08): $4.56 billion ($261/share)
• P/B: 1.20
• Tangible book value minus entire CDS portfolio of $596 million
as of 10/24/08 (assume 30% tax rate): $4.14 billion ($237/share)
• P/B (adjusted): 1.32

Summary: We think Fairfax’s core business is worth 1.3-1.5x

book value, so at today’s price, we’re getting a very good,
growing insurance company at a good price, with a free call
option on Fairfax’s CDS portfolio.

Note: Tangible book value excludes preferred stock and goodwill.

EchoStar Corporation (SATS)

Situation Analysis
• Spun off from EchoStar Communications (DISH) in January 2008
• >50% controlled by Chairman and Founder Charles Ergen
• No analyst coverage
Elements of Value
• Fixed satellite services
• Set-top boxes (STB)
• Sling Media
• Joint ventures
• Cash and investments
Investment Thesis
• SATS is valued in the market at approximately satellites plus
investments, meaning you get STB and technology for free

Appendix F: Echostar
SATS Since Its IPO on 1/1/08


Share price (12/31/08): $14.87

Shares outstanding: 90 million
Market cap: $1.3 billion
Less cash: $1.3 billion
Enterprise value: $0

Book value/share: $33.12

Price/Book: .45x
Tangible book value/share: $28.27
Price/Tangible Book: .53x

Fixed Satellite Services

• Six owned and three leased satellites

– Broadcast services
– Government services
– Network services
– Satellite internet protocol
• Seven broadcast centers
– State of the art
• Leased fiber capacity

Set-Top Box Business

• LTM revenues: $1.7 billion

• Two-year contract to provide to DISH
– Likely renewal as long as DISH is independent
– Cost plus agreement
• Potential to sell to DISH competitors
– Satellite and cable
– Very high technology – better mousetrap
• Slingbox
• Independent manufacturer EBITDA margins run 15-20%

Sling Media

• Acquired in October 2007 for $380 million

• Slingbox provides time and location video shifting
• Competitive advantage for Echostar’s set-top boxes
• Technology incubator

Sum of the Parts Valuation

Cash and investments: $1.3 billion

Satellites/Broadcast: $0.8 billion
$2.1 billion ($23.33/share)

Set-top box: $1.6-$2.4 billion

Technology: $0.4 billion
$2.0-$2.8 billion ($22.22-$33.11/share)

Total value: $45.55-$54.44/share, 206%-266% above today’s price


• Tivo lawsuit
• Role of set-top boxes
• AT&T
• Satellite utilization
• Expected writeoffs

The Original Structure of the Long Beach Mortgage Loan Trust
2006-8, a Typical Bubble-Era (2006) Subprime Pool of Mortgages
Expected Rating
Class Principal Balance($) Credit Enhancement
I-A AAA/Aaa 366,091,000 18.60% 81.4%
II-A1 AAA/Aaa 322,788,000 18.60% of the
II-A2 AAA/Aaa 124,929,000 18.60% was
II-A3 AAA/Aaa 236,928,000 18.60% rated
II-A4 AAA/Aaa 73,178,000 18.60%
M-1 [AA+]/Aa1 43,493,000 15.45%
97.95% of
M-2 [AA+]/Aa2 39,351,000 12.60%
the pool
M-3 [AA]/Aa3 24,853,000 10.80% was rated
M-4 [AA]/A1 22,092,000 9.20% investment
grade by
M-5 [AA-]/A2 21,401,000 7.65% S&P;
M-6 [A+]/A3 19,330,000 6.25% 96.3% by
M-7 [A]/Baa1 13,807,000 5.25% Moody’s
M-8 [A-]/Baa2 11,046,000 4.45%
M-9 [BBB+]/Baa3 10,355,000 3.70%
M-10 [BBB]/Ba1 8,975,000 3.05%
M-11 [BBB-]/Ba2 13,807,000 2.05%

Appendix G: Distressed debt (RMBS tranche)

C Unrated 28,303,000
Source: SEC filings
Total -66-$1,380,727,000
Characteristics of the Subprime Mortgages in the Pool

Scheduled Principal Balance $1,380,729,811

Average Scheduled Principal Balance $214,166 High interest rate
Number of Mortgage Loans 6,447

Weighted Average Gross Coupon 8.459% Deep subprime (cutoff is

660). These are low-
Weighted Average FICO Score 639
income people with very
Weighted Average Original Loan-to-Value* 81.17% poor credit histories.
Weighted Average Original LTV with Mort. Insur** 78.29%
Weighted Average Combined Original LTV*** 89.87%
Very high debt-to-
Weighted Average Debt-to-Income 39.41% income – these
homeowners are
Weighted Average Original Term 376 months stretched – and as the
next page shows, for
Weighted Average Stated Remaining Term 375 months
nearly half of the loans
Weighted Average Seasoning 1 month in the pool income was
Weighted Average Months to Roll 33 months not verified (i.e., the loan
was made based on
*Original LTV for all first lien loans and combined original LTV for all second lien loans
stated income, so called
**Original LTV for all first lien loans and combined original LTV for all second lien loans, in each case adjusted for MI liar’s loans)
***Combined LTV including simultaneous seconds for all first lien loans and combined original LTV for all second lien loans
Source: Form FWP, filed 9/14/06
Characteristics of the Subprime Mortgages in the Pool (2)
Adj Rate Mortgage 82.59% Full 52.33% Nearly
Fixed Rate Mortgage 17.41% Limited 5.80%
Stated 41.87% half are
ARM—2 Yr/6 Mth 21.71% Cash-Out Refi 41.33% liar’s
ARM—2 Yr/6 Mth 40 Yr 8.15% Purchase 51.74% loans
ARM—2 Yr/6 Mth IO 4.71% Rate/Term Refi 6.93%
ARM—3 Yr/6 Mth 1.74%
ARM—3 Yr/6 Mth 40 Yr 1.23% Condominium 8.07% More than
ARM—3 Yr/6 Mth IO 0.33% Planned Unit Development 15.37%
ARM—5 Yr/6 Mth 7.79%
half reset
Single Family 70.51%
ARM—5 Yr/6 Mth 40 Yr 3.30% Townhouse 0.09% in July &
ARM—5 Yr/6 Mth IO 2.49% Two to Four Family 5.96% August,
Balloon—2 Yr/6 Mnth 23.00%
Balloon—3 Yr/6 Mnth 1.33% Investor 7.53%
Balloon—30 Year 1.34% Owner-Occupied 91.08%
Balloon—5 Yr/6 Mnth 6.80% Second Home 1.39%
Fixed—15 Year 0.26%
Fixed—20 Year 0.00% First Lien 94.02%
Fixed—30 Year 14.66% Second Lien 5.98%
Fixed—40 Year 1.15% More
Top 5 Locations:
Not Interest Only 92.46% California 39.55% than
Interest Only 7.54% Florida 11.84% half are
Texas 4.60% in CA &
Prepay Penalty: N/A 24.87% Maryland 4.51%
Prepay Penalty: 12 months 6.23% Washington 4.37% FL
Prepay Penalty: 24 months 37.32%
Prepay Penalty: 36 months 31.58% PMI Coverage 9.76%
Prepay Penalty: 48 months 0.01% No PMI Coverage 90.24%

Source: SEC filings

The Structure of the Pool Today
The pool is only 27 months old, yet already the M-7 through M-11 and the
C tranches are already wiped out and the M-6 tranche is almost wiped out
All payments from groups 5 & 6 go to this tranche, which has been paid down from $323 million
to $71 million. Once this tranche is paid off (likely by 5/09, all payments go to the IIA2 tranche
until all of the M tranches are wiped out; then remaining IIA tranches share payments pro rata)

This is the
tranche we
purchased at
34% of par --
$125 million
face, which
we own at a
valuation of
$42.5 million
(we own
8.9% of the

Source: Amherst
The Catastrophic Outcomes of the Original Pool
in the 26 Months Since Inception

The pool has shrunk to $888 million due

90% Prepaid, $254 (18.4%) to $254 million of prepayments/
refinancings and $239 million of defaults,
which at a 60% severity, has led to $143
80% Recovery from Liquidations,
(6.8%) million of realized losses

$387 million has gone to the top tranches
in this pool: $254 million from prepays
60% plus $94 million of recovery from
Performing, $461 (33.4%)
liquidations plus $39 million in interest
payments made by performing loans

40% Defaulted (30 days), $55 (4.0%)

Defaulted (60 days), $38 (2.8%)
As performing loans default, they go
through 5 stages, the last of which,
Defaulted (90 days), $100 (7.3%)
30% REO, is followed by a liquidation: a sale
of the house, typically via auction. Upon
Foreclosure, $133 (9.6%)
liquidation, losses are realized (60% so
far in this pool) and recoveries (40%)
Real Estate Owned, $101 (7.3%) are remitted to the pool

Losses on Liquidations, (10.4%) The realized losses are quickly

wiping out the sub-AAA tranches

The Pool is Defaulting at Catastrophic Rates
Severity Monthly default rate Monthly prepay rate
Realized Loss Cumulative defaults Annualized default rate Annualized
prepay rate
49.5% of the original Date Loss ($M) Severity CDX sTr cTr SMM vPr
pool has defaulted in 10/1/2008 $16.2 61.0% 49.5% 4.9% 45.3% 0.7% 8.1%
9/1/2008 $14.7 58.6% 47.8% 5.1% 46.6% 1.0% 11.4%
only 26 months (!) and
8/1/2008 $12.9 59.3% 45.9% 4.9% 46.3% 0.8% 9.2%
approximately 5% of 7/1/2008 $13.0 55.6% 44.1% 5.0% 46.0% 0.5% 5.8%
the performing loans 6/1/2008 $11.5 56.7% 42.0% 4.5% 42.5% 0.6% 7.0%
5/1/2008 $10.7 64.2% 40.1% 4.8% 44.6% 1.1% 12.4%
are defaulting every
4/1/2008 $7.7 61.0% 37.9% 3.4% 34.0% 0.7% 8.1%
month. At this rate, 3/1/2008 $4.7 64.2% 36.3% 4.3% 41.0% 0.7% 8.1%
45% of performing 2/1/2008 $6.7 58.4% 34.1% 5.0% 46.0% 0.7% 8.1%

loans will default in 12 1/1/2008 $6.8 66.7% 31.4% 4.9% 45.3% 0.8% 9.2%
12/1/2007 $5.5 62.8% 28.7% 3.8% 37.2% 0.6% 7.0%
months, while fewer 11/1/2007 $4.4 49.9% 26.4% 4.9% 45.3% 0.8% 9.2%
than 10% of the pool 10/1/2007 $2.2 54.7% 23.4% 3.9% 38.0% 0.6% 7.0%
will prepay/refi. Upon 9/1/2007 $5.9 69.8% 20.8% 3.8% 37.2% 0.9% 10.3%
8/1/2007 $0.5 40.4% 18.2% 3.0% 30.6% 1.0% 11.4%
default, severities are 7/1/2007 $6.1 106.5% 16.1% 3.2% 32.3% 1.4% 15.6%
around 60% 6/1/2007 $0.2 34.8% 11.7% 3.5% 34.8% 1.3% 14.5%
5/1/2007 $0.2 66.7% 10.9% 2.7% 28.0% 1.2% 13.5%
4/1/2007 $0.0 0.0% 8.7% 2.4% 25.3% 1.1% 12.4%
3/1/2007 $0.0 0.0% 6.7% 2.8% 28.9% 1.5% 16.6%
2/1/2007 $0.0 0.0% 4.2% 2.8% 28.9% 1.1% 12.4%
1/1/2007 $0.0 0.0% 1.5% 1.4% 15.6% 2.9% 29.8%
12/1/2006 $0.0 0.0% 0.2% 0.2% 2.4% 2.8% 28.9%
11/1/2006 $0.0 0.0% 0.0% 0.0% 0.0% 1.0% 11.4%
10/1/2006 $0.0 0.0% 0.0% 0.0% 0.0% 0.5% 5.8%
Source: Amherst Securities
9/1/2006 $0.0 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Cumulative Defaults Since Inception


% of



Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct-
06 06 06 06 07 07 07 07 07 07 07 07 07 07 07 07 08 08 08 08 08 08 08 08 08 08

Source: Amherst Securities

At Today’s Prices, the Yields Under
Almost Any Scenario Are Spectacular
• Monthly default rates stay at 5% forever (last month was 4.9%)
• Annual prepayment rate drops to 3% (last month was 8.1%)
• New delinquencies suffer 75% severities (last month was 61%)

Severity of Already-
Tranche Writedown Yield @ 35% of Par
Scenario Defaulted Mortgages
1 55.5% 26.1% 139.0%
2 58.0% 31.1% 115.8%
3 60.5% 41.8% 71.2%
4 63.0% 45.5% 57.5%
5 65.5% 49.2% 45.5%
6* 65.5% 67.7% 2.2%

* Even in the Armageddon scenario (no prepays, 7%

monthly default rate and the servicer stops advancing
money), you don’t lose money.
Source: Amherst Securities
Appendix H: Bio of Christopher D. Woolford, CFA
Chris Woolford joined T2 Partners in January 2009. Prior to joining T2 Partners, Mr. Woolford spent
nearly five years with Spencer Capital Management, a value-oriented hedge fund, most recently as

Before graduate school, Mr. Woolford was an independent financial consultant and an Associate with
Chilmark Partners, a merchant bank that specializes in providing advice to, and investing in, financially
distressed companies.

Mr. Woolford received an MBA in Finance from the Wharton School, an MA in International Studies
from the Lauder Institute at the University of Pennsylvania, and graduated Phi Beta Kappa from the
University of Chicago with a BA in Economics. Mr. Woolford holds the CFA designation.

Mr. Woolford lives in Manhattan with his wife and two sons.

T2 Accredited Fund, LP (the “Fund”) commenced operations on January 1, 1999. The Fund’s
investment objective is to achieve long-term after-tax capital appreciation commensurate with moderate
risk, primarily by investing with a long-term perspective in a concentrated portfolio of U.S. stocks. In
carrying out the Partnership’s investment objective, the Investment Manager, T2 Partners Management,
LLC, seeks to buy stocks at a steep discount to intrinsic value such that there is low risk of capital loss
and significant upside potential. The primary focus of the Investment Manager is on the long-term
fortunes of the companies in the Partnership’s portfolio or which are otherwise followed by the
Investment Manager, relative to the prices of their stocks.

There is no assurance that any securities discussed herein will remain in Fund’s portfolio at the time you
receive this report or that securities sold have not been repurchased. The securities discussed may not
represent the Fund’s entire portfolio and in the aggregate may represent only a small percentage of an
account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings
or sectors discussed were or will prove to be profitable, or that the investment recommendations or
decisions we make in the future will be profitable or will equal the investment performance of the
securities discussed herein. All recommendations within the preceding 12 months or applicable period
are available upon request.

Performance results shown are for the T2 Accredited Fund, LP and are presented gross and net of
incentive fees. Gross returns reflect the deduction of management fees, brokerage commissions,
administrative expenses, and other operating expenses of the Fund. Gross returns will be reduced by
accrued performance allocation or incentive fees, if any. Gross and net performance includes the
reinvestment of all dividends, interest, and capital gains. Performance for the most recent month is an

The fee schedule for the Investment Manager includes a 1.5% annual management fee and a 20%
incentive fee allocation. For periods prior to June 1, 2004, the Investment Manager’s fee schedule
included a 1% annual management fee and a 20% incentive fee allocation, subject to a 10% “hurdle”
rate. In practice, the incentive fee is “earned” on an annual, not monthly, basis or upon a withdrawal
from the Fund. Because some investors may have different fee arrangements and depending on the
timing of a specific investment, net performance for an individual investor may vary from the net
performance as stated herein.

The return of the S&P 500 and other indices are included in the presentation. The volatility of these
indices may be materially different from the volatility in the Fund. In addition, the Fund’s holdings
differ significantly from the securities that comprise the indices. The indices have not been selected to
represent appropriate benchmarks to compare an investor’s performance, but rather are disclosed to
allow for comparison of the investor’s performance to that of certain well-known and widely recognized
indices. You cannot invest directly in these indices.

Past results are no guarantee of future results and no representation is made that an investor will or is
likely to achieve results similar to those shown. All investments involve risk including the loss of
principal. This document is confidential and may not be distributed without the consent of the
Investment Manager and does not constitute an offer to sell or the solicitation of an offer to purchase any
security or investment product. Any such offer or solicitation may only be made by means of delivery
of an approved confidential offering memorandum.