Vii 2013 Nov Issue

ValueInvestor
November 27, 2013
The Leading Authority on Value Investing
INSIGHT
Inside this Issue
FEATURES
Opportunity Knocks
The small-cap universe is littered with stories of dashed hopes and broken dreams. All of which creates opportunity for Buzz Zaino and Bill Hench.
INVESTOR INSIGHT
ll value investors have to see beyond adversity in making their bets, but Buzz Zaino says his tolerance for ugliness may exceed that of most of his Royce & Associates colleagues. I am considered a bit more adventurous, he says. His sense of adventure has certainly paid off for investors. The $2.4 billion (assets) Royce Opportunity Fund hes managed since 1998 has earned a net annualized 13.7% over the past 15 years, vs. 10.7% for comparable small-cap value funds tracked by Morningstar. Often investing behind broad-based themes, Zaino and co-manager Bill Hench see particular upside today in areas such as banking, residential and non-residential construction, commercial vehicles and niche See page 2 technology.
Investor Insight: Buzz Zaino Casting broadly for small-cap bargains and finding them in M.D.C., Trustmark, Orient-Express Hotels and RTI International. PAGE 1 Investor Insight: Broad Run Finding value investments in growing companies such as Aon, OReilly Automotive, American Tower and Diamond Hill. PAGE 1 Strategy: Eric Rosenfeld A long-time activist describes the categories of opportunity we see over and over again. PAGE 17 Uncovering Value: Pulse Seismic Betting on a beautiful business model marred only by customers cyclical spending. PAGE 21 Editors Letter On keeping the hounds of bull-market frustration at bay. PAGE 22
INVESTMENT HIGHLIGHTS INVESTMENT SNAPSHOTS
Aeropostale American Tower Aon Diamond Hill Investment M.D.C. Holdings OReilly Automotive Pulse Seismic RTI International Metals Sonic Automotive Trustmark
Royce Opportunity Fund Buzz Zaino (l ), William Hench (r) Investment Focus: Seek companies with unrecognized assets, turnaround upside, ignored growth potential or dashed-butstill-interesting expectations.
Repetitive Advantage
INVESTOR INSIGHT
Identifying high-quality, growing companies is far easier than not paying up to own them. The managers of Broad Run Investment have excelled at both.
PAGE
19 14 12 15 5 13 21 6 7 4
Broad Run Investment Management (l to r) Ira Rothberg, David Rainey, Brian Macauley Investment Focus: Seek to buy companies when their ability to grow is underestimated and then hold them patiently while they compound value over time.
fter five years together as the analytical team supporting Chuck Akres market-trouncing FBR Focus Fund, Brian Macauley, David Rainey and Ira Rothberg were given a straightfoward mandate in taking over the funds management upon Akres departure in mid-2009. Basically, dont screw it up, says Rainey. They certainly havent. Their firm, Broad Run Investment Management, subadvises the renamed $1.4 billion Hennessy Focus Fund and has earned a net annualized 19.3% since the changeover, vs. 16.6% for the Russell 3000. Targeting compounding machines over proverbial cigar butts, the trio today sees opportunity in aftermarket car parts, insurance brokerage, cellphone towers and See page 9 investment management.
www.valueinvestorinsight.com
Other companies in this issue:

Audience, Com Dev, Commercial Metals, Commercial Vehicle Group, Dana, Dun & Bradstreet, Encore Capital, Exar, Google, J.C. Penney, Lamar Advertising, Meritor, Micros Systems, Orient-Express Hotels, II-VI Inc.
I N V E S T O R I N S I G H T : Royce Opportunity
Investor Insight: Royce Opportunity

Royce & Associates Buzz Zaino and Bill Hench describe which types of assets the market frequently misprices, why they focus on somewhat narrow valuation metrics, one of the key benefits of age for an investor, why they see upside in Trustmark, M.D.C. Holdings and RTI International Metals, and why they see downside in Sonic Automotive.
Your funds marketing materials lay out four distinct investment themes on which you focus. Before you tell us what those are, were curious whether those categories have been consistent, or have come and gone over the years. Buzz Zaino: In the late 1970s I was running a successful fund at Lehman Brothers and the marketing department asked me to define more clearly what I was doing. I basically went back and looked at all our successful investments and identified those four themes, which havent changed since. Category number one is companies with unrecognized asset values. Elaborate on what that tends to mean. BZ: Were looking for companies with market values materially below what we consider the probable liquidating value of their assets. Those assets could be physical, like land or capital equipment, or intangible, like the value of a brand. A typical example is a company like Steinway, which has a brand you cant duplicate in the world market for pianos. But with the latest quarterly earnings often determining the price of the stock, especially in small-caps, market values in companies like this may not reflect intangible asset values. Steinway ended up being taken private this past summer for a substantial premium because the buyer could assume the franchise was long-lived and that profitability could develop on that basis. [Note: Paulson & Co. bought Steinway in August for $40 per share, almost double its price at the beginning of the year.] A current example of a similar concept would be Orient-Express Hotels [OEH]. On a hard-asset basis, the typical way to value a hotel company would be to start with the number of rooms, multiply that by the construction cost per room, subtract debt and divide by the number of
November 27, 2013
shares to arrive at asset value per share. With Orient-Express, you cant do that. They own the Hotel Cipriani in Venice. They own the Splendido hotels in Portofino. The Copacabana in Rio. The Mount Nelson in Cape Town. These are incredible assets that as trophy properties are likely worth considerably more than the value the market is putting on them. You
relatively early, it usually works pretty well from an investment perspective. Bill Hench: We own a semiconductordevice company called Exar [EXAR] that has so far been a classic case of what Buzz is describing. The company had a great R&D culture, but had spread itself too thin pursuing business where it had no real advantage. At the beginning of 2012 the board changed the CEO and brought in Lou DiNardo, who had turned around and sold a small technology company we had owned called Xicor. Half of Exars market cap when he came on board was in cash and the stock looked statistically interesting even if we hadnt known him. He laid out a basic plan to refocus and streamline the company, which has significantly increased earnings power. That hasnt been obvious because the business cycle hasnt been great, but the stock has still gone from $6 to $12 and in a good cycle could do much better. Your two remaining categories, undervalued growth and interrupted earnings, would seem to play somewhat more on market psychology. Describe how that can create opportunity. BZ: Undervalued-growth ideas tend to be of two kinds. One is the company in what the market perceives to be an uninteresting industry, but which in fact excels in a higher-growth niche in the industry. The other is the company that has turned itself around after a difficult period and is starting to grow nicely again, but the market hasnt yet recognized it. Some portfolio managers dont want to hear about it because they had a dismal experience with the stock and may assume any recent good news is just luck. Theres a similar dynamic in what we call interrupted-earnings names. These companies earnings have been growing
Value Investor Insight 2
ON TURNAROUNDS: Its a common theme for us. Small companies often get into trouble because they arent well managed.
have Chinese billionaires spending $80 million for a condo in Manhattan how does that translate into what someone might pay for the Cipriani? Investment theme number two is turnarounds. Do these tend to be more company-specific or tied to some sort of business or product cycle? BZ: Both, but our preference is probably for when new management is working on an existing base of business. Small companies often get into trouble because they are not well managed. A typical pattern might be that the founder of the company is an engineer and knows products, or may be a good salesman, but doesnt know how to manage the overall business as it grows. They buy dumb things, invest in projects going nowhere, or let costs get out of control. One day the board confronts the mess and brings in someone who refocuses the business on whats working, cleans up the balance sheet, installs six-sigma manufacturing processes and takes 2% operating margins to 12%. If we can get in on that
rapidly before hitting some sort of wall that scares everyone away, but that doesnt necessarily mean the strong growth is gone forever. Maybe theyve recently gone public and are dealing with higher costs when operating as a stand-alone company. Maybe theyre transitioning from one product or service iteration to the next, and growth of the new iteration isnt yet compensating for the decline of the old. At any sign of weakness the growth investors are likely to panic, which in turn hurts the share price. BH: A lot of these kinds of ideas tend to be niche-oriented technology companies. We own a company called Audience [ADNC], which makes audio and voice processors used in smartphones. It was early to market with high-quality products and grew rapidly as smartphones became more ubiquitous and sophisticated. Within a quarter or two of going public, though, the company reported a slowdown in growth. Rather than attribute it to the timing of customers and Audiences own product launches, the market assumed it was a bigger problem, that lower-end phones were taking big share and Audience wasnt well-positioned in that end of the market. The stock went from $18 to $6. When we stepped back and looked at the market and the companys potential in it, we saw a pretty nice growth story, in the 20%-plus range per year. It has a beautiful balance sheet, with no debt and $5 per share in cash. The stock has come back a bit [to a recent $10], but is still well off from what we think the companys performance can eventually justify. Youve said youre considered more adventurous than many of your Royce & Associates peers. How so? BZ: When we look at balance sheets, for example, we tend to project forward based on what we think can happen as opposed to the situation today. We also look at earnings more on a normalized basis rather than against the trailing 12 months. Were all value investors, but I may be more willing than others to look at
November 27, 2013
businesses that are going through a moredifficult period. Do you have any unique ways of generating ideas? BH: I dont know how unique it is, but we get a lot of ideas from trade journals. On my desk right now I have American Metal Market, Womens Wear Daily, Aviation Week, TradeWinds and Engineering News. What we like about the trades is that its more management talking to
a Russian firm at $63. In a vacuum, that information on the new president would have meant very little. In context, which you get from following these companies at a detailed level, it meant a lot. You were early and mostly right in betting throughout the value chain on a rebound of the U.S. housing market. Are any sectors showing similar promise today? BZ: One would be non-residential construction. The Architecture Billings Index has been in positive territory for almost six months. When we talk to companies in our portfolio that can see developments that arent in the ABI like an uptick in bid requests and companies building staff we think theres reason to believe well have a nice recovery in this sector over the next several years. In investing around this kind of theme were particularly interested in companies that during the fallow period have reoriented themselves to increase their earnings power. A good example in the portfolio today is Commercial Metals [CMC], which both manufactures and recycles steel and other metal products. Carl Icahn made a bid for the company in 2012 and it fought him off, saying its new management was fully capable of increasing the profitability of the business, which it has. If the cycle improves, the company should have much higher revenues on a much lower cost base, which obviously should benefit the bottom line. BH: Were also optimistic about the market for commercial vehicles. The longterm potential in emerging markets makes this more of a growth industry, but as China has slowed down, order rates for big and small players in the market have fallen. This may not turn around right away, but we believe over the next 18 to 24 months that order rates will pick up again and benefit the entire value chain, much of which has been consolidating. We own several names that could benefit, including Meritor [MTOR], which supplies drive-train systems, Commercial Vehicle Group [CVGI], which manufactures
ON TRADE JOURNALS: We like that its more management talking to management than management talking to Wall Street.
management, not management talking to Wall Street. That makes the discussion a bit more candid about problems and opportunities. We find that both refreshing and helpful. BZ: This goes back several years, but one of the happiest examples of my picking up something useful in the trades was a small item on a management change at a company called Oregon Steel. It was a unique company in that it was the only steel-plate manufacturer west of the Mississippi, so if you were in the western United States and wanted plate, your alternative to using Oregon Steel was to truck it over the Rocky Mountains or import it by ship from Asia. The problem with the company was that management was locked in an ugly fight with the unions that had lasted for years. So at a time when the stock was around $3, I noticed in a daily update from American Metal Market that Oregon Steel named a new president, from another steel company that had wonderful labor relations. I went to the trading desk and ordered one million shares. Within a couple years the company was bought out by
seating and electrical systems, and Dana [DAN], which makes drivetrains. Where do you focus your valuation work? BZ: We focus on two valuation criteria upfront, price-to-book and price-to-sales. The rationale on price-to-book is that book value is a fairly rational concept of what has been invested in the company with an expected return. It may be they put up a new greenfield plant expecting demand of 10, but it starts out at only 2 or 3. So theyre losing money on it. If the economy turns down, theyre losing a lot of money on it. So the market ascribes no value or negative value to the plant, which shows up in a low price-to-book. If you can make a case that demand eventually will be 10, or that the cycle is going to improve, that asset in the future may be worth a lot more than it is today. That doesnt mean every low price-to-bookvalue stock is a good idea, but its a fertile place to look. We see price-to-sales as an indicator of upside leverage. There are certainly lots of opinions out there on J.C. Penney [JCP], but its quite interesting to us that its stock trades at 0.2x revenues at a time when Target and Macys go for 0.6x to 0.7x. If the business isnt going away and can get even part of the way back to where it was, the leverage in the shares is very high. If the multiple got to 0.3x still half of its competitors youd have a big rise in the share price. Werent you short J.C. Penney in Royce Opportunity Select, your long/short fund? BH: We were. Based on our experience investing in retail, we thought it would be very difficult to pull off such big changes in the product mix, the target customer and the sales strategy. Things like that can sound great at first, but six or nine months later management is explaining how the old customer went away faster and the new customer didnt sign on as quickly as expected. But thats not the story today with J.C. Penney and the stock is a lot cheaper.
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Royce Opportunity holds some 300 positions. Why so diversified? BZ: Part of it has to do with investing most of the portfolios assets in small- and micro-cap names where you dont want to give away too much liquidity. Im also pretty strict on price and theres only so much stock available at the price Im willing to pay. Id rather have fewer shares in a name and an optimal cost basis than have to compromise on price to build a bigger position. I guarantee there will be disasters in the portfolio every year. A company will
INVESTMENT SNAPSHOT
cook its books. Management will make a terrible capital-allocation decision. I just dont want a few stocks destroying the portfolio. Walk through your investment case for Mississippi-based bank holding company Trustmark [TRMK]. BH: Weve identified what we believe is an opportunity in smaller banks as a result of the consolidation we expect in the industry as small banks find it more difficult to support the regulatory infrastructure they need in order to be compliant in
Trustmark
Valuation Metrics
(@11/26/13):
(Nasdaq: TRMK)
Business: Provider of banking, insurance and wealth management services through more than 200 branches located primarily in Mississippi, Texas and Alabama. Share Information
(@11/26/13):
TRMK Russell 2000 P/E (TTM) 15.9 75.5 Forward P/E (Est.) 15.5 26.9 EV/EBITDA (TTM) n/a
Largest Institutional Owners
(@9/30/13):
Price 28.05
52-Week Range Dividend Yield Market Cap 21.30 28.88 3.2% $1.88 billion $555.1 million 34.8% 21.0%
Financials (TTM):
Revenue Operating Profit Margin Net Profit Margin
TRMK PRICE HISTORY 30 30
Company BlackRock State Street Vanguard Earnest Partners Allianz Asset Mgmt Shares Short/Float
% Owned 12.0% 5.4% 5.2% 4.1% 3.9% 8.7%

30
Short Interest (as of 10/31/13):
Clos
25 25
25
20 20
20
15 15 2011 THE BOTTOM LINE
2012
2013
15
The company is well positioned as a potential acquiror of small banks in regions of the U.S. that are benefitting from capital spending meant to take advantage of increasingly plentiful and cheap energy sources, says Bill Hench. At a low-teens multiple on his $3.25-per-share estimate of normalized earnings, the shares would trade at around $40.
Sources: Company reports, other publicly available information
todays market. But were not focused on the banks that look like takeover targets. Instead, were looking at those that are likely to be doing the buying. When you buy a bank, particularly in an overlapping geography, you can take on the assets and liabilities without needing to keep a lot of the costs. As that positively impacts acquiring banks earnings and returns over time, theres also the potential for multiple expansion in the stocks. There are a few things that interest us specifically about Trustmark. It has shown an ability to accumulate deposits, branches and customers at pretty good valuations through acquisition, most notably in the purchase earlier this year of BancTrust, the third-largest bank in Alabama. We like that it tends to operate in markets with populations that use banks in a more traditional way, resulting in it having lots of basic passbook savings accounts and 30-year mortgages. Nearly three-quarters of its total deposits are in non-interestbearing accounts. Also, while you wouldnt think immediately of their markets as strong ones, the industrial renaissance people talk about in the U.S. because of plentiful and cheap energy is resulting in a lot of economic activity in places like Alabama and Mississippi, where big multinationals are investing in manufacturing plants, chemical plants and energy-related facilities. That should be a tailwind for Trustmark. BZ: This is true of almost all banks, but if were right in our assumptions about the economy, we expect at least a gradual rise in loan volume and in interest rates going forward. That should result in more loans with better net interest margins, which falls straight to the bottom line. Trustmarks net interest margins today are about 400 basis points. At a more normal level of at least 480 basis points, thats a 20% improvement in earnings right there. What upside do you see in the shares, now trading at around $28? BZ: As profitability improves and theres better recognition of their non-banking
November 27, 2013
operations such as wealth management and insurance, wed expect the shares to be worth closer to 1.5x total assets, rather than about 1x today. Coming at it another way, wed expect the shares to earn a low-teens multiple on our $3.25 per share estimate of earnings as the interest-rate environment returns to something closer to normal. Either way, we arrive at a potential value for the stock at somewhere around $40. Homebuilder stocks have been on a bit of a rollercoaster. Why are you still high on M.D.C. Holdings [MDC]?
INVESTMENT SNAPSHOT
BH: Buzz has known M.D.C.s Chairman and CEO Larry Mizel for 20 years. He was one of the first homebuilder CEOs we met with when we started to explore investing in a housing recovery. One of the things that stood out was his description of the extent to which private builders in some of the companys major markets had gone out of business. That told us that if things did recover, you could construct a thesis for a company like this with better margins and better profitability even with significantly less than the two million new-home starts we had in the U.S. prior to the crisis.
M.D.C. Holdings
(NYSE: MDC)
Valuation Metrics
(@11/26/13):
Business: Development, construction, financing and sale of single-family detached homes, primarily in U.S. Western and Middle Atlantic states, as well as in Florida. Share Information
(@11/26/13):
MDC Russell 2000 P/E (TTM) 4.8 75.5 Forward P/E (Est.) 15.9 26.9 EV/EBITDA (TTM) 17.6
(@9/30/13):
Price 30.41
52-Week Range Dividend Yield Market Cap 27.00 42.41 3.3% $1.49 billion $1.61 billion 6.2% 19.4%
Financials (TTM):
MDC PRICE HISTORY 50 50 40 40 30 30 20 20 10 10 2011 THE BOTTOM LINE
Company % Owned BlackRock 8.9% State Street 6.9% Advisory Research 5.6% Vanguard 4.7% DePrince, Race & Zollo 3.1%
Shares Short/Float
8.6%
50 40 30 20 10
Clos
2012
2013
While the market seems to have concluded that the recovery in the housing market may not have legs, Bill Hench believes it will and that the company is well-positioned both strategically and operationally to benefit from it. At what he considers a reasonable multiple on his $5-per-share estimate in earnings power, the shares would be worth $40.
Whats hurt homebuilder stocks over the past six to nine months has been a lull in activity after an uptick in mortgage rates. The market almost seemed to conclude the recovery in housing was over. Our view is that part of the lull came from builders rapidly increasing prices because they could and pulling back on freebies to get people to buy. That led to a temporary pullback from buyers, but if you look at the improving employment situation and assume the economy continues to grow slowly, theres a very good chance they come back and homebuilders continue to move more product at better prices. Housing starts in the U.S. have been below what economists consider the normal annual demand of 1.1 to 1.3 million units for years theres a lot of pentup demand. Is M.D.C. better positioned to benefit from that? BH: It operates in what would be considered good growth markets, including Colorado, California, Arizona and the Maryland and Virginia suburbs around D.C. Its price points are not at the top or bottom of the market, which should work out well if broad-based demand improves. One thing M.D.C. does somewhat differently is not to speculate too much on accumulating land, which is one reason it was able to come back more quickly after the crisis. That protects the balance sheet and makes this a somewhat safer play. With the shares off nearly 30% from their January high, how are you looking at valuation at todays price of $30.40? BZ: Having cut back dramatically on its cost structure during the crisis and with a lot of independent competitors out of business, we estimate in a gradually improving market that M.D.C. can produce a 20% return on equity and earn close to $5 per share in earnings. With an 8x multiple, typical in the industry when earnings are good, the stock would trade at $40. Just as the down cycle lasted for several years, we believe the up cycle can as well.
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There will likely be a hiatus from time to time, as there has been this year, but we are expecting the growth runway here to be fairly long. Whats driving your avid interest in titanium-products producer RTI International Metals [RTI]? BZ: Were attracted to both the nature of the business and to the long-term potential of RTIs primary end-market of commercial aerospace. The company converts a raw material called sponge into titanium, which it then fabricates according to
INVESTMENT SNAPSHOT
the specifications of the end customer. Titanium is stronger, lighter and more heatand corrosion-resistant than most alternatives, which makes it ideal for aerospace applications, but its also increasingly used in things like energy exploration-and-production equipment and medical devices. It isnt easy to produce, so the barriers to competitive entry are fairly high. RTI also has entrenched relationships with many of the big players in its markets, including Boeing, Airbus, Lockheed Martin, BAE Systems, BP and Chevron. More than half of the business is in commercial aerospace, which is being
RTI International Metals

(NYSE: RTI)
Valuation Metrics
(@11/26/13):
Business: Production, sale and distribution of titanium mill products, extruded shapes, form-ready parts and engineered components in North America, Europe and Asia. Share Information
(@11/26/13):
P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

(@9/30/13):
RTI Russell 2000 39.4 75.5 24.6 26.9 9.8
Price 35.19
52-Week Range Dividend Yield Market Cap 23.93 35.92 0.0% $1.08 billion $775.5 million 9.3% 3.5%
Financials (TTM):
RTI PRICE HISTORY 40 40 35 35 30 30 25 25 20 20 2011 THE BOTTOM LINE
Company Fidelity Mgmt & Research Eagle Asset Mgmt Dimensional Fund Adv BlackRock Carlyle Group Shares Short/Float
% Owned 14.9% 10.4% 8.7% 8.4% 6.6% 13.7%

40 35 30 25 20
Clos
2012
2013
The company is a small player in the commercial-aerospace ecosystem, says Buzz Zaino, but the titanium products it provides should be in high demand as the absolute market for airplanes grows, the size of planes increases and the use of titanium per plane expands. He hesitates to set a target price, but considers the companys upside open-ended.
driven by the industrialization and growing middle classes in emerging markets. Boeing and Airbus have huge backlogs and are ramping up big new build programs for things like the Boeing 787 and Airbus A380. I heard a few years ago that India had only maybe 12 airports that had the infrastructure to handle modern airplanes, which shocked me, but its indicative of the growth potential for air travel as the demand and infrastructure to serve it builds. RTI is a relatively tiny player in the ecosystem, but it benefits as the absolute market for airplanes grows, the size of planes increases, and the use of titanium per plane expands. It has invested something on the order of $320 million in new plant and equipment over the past five years, which we believe is about to start paying off. How do you see all that translating to the income statement and to the stock price, now at around $35? BZ: This is a case where its very difficult to make precise estimates. Part of that is the dynamic we often see in a business like this where the end customers in this case plane manufacturers have more leverage on pricing early in the production cycle, but as production ramps up providers like RTI of relatively scarce products get much better prices in the second- and third-level contracts. What we do know is that as the cycle ramps up, RTIs operating margins should grow significantly. They were 33% in 2007, versus around 20% in the mostrecent fiscal year. When the upside is more open-ended, as we think the case is here, you want to make sure the valuation is reasonable so youre protected on the downside. RTI trades for about 1.35x both book value and revenues, which based on history and against peers is extremely reasonable for an early stage in the cycle. If were right about that, both earnings and the multiple should expand materially over the next few years. In this case we dont feel the need to be more precise than that for the time being.
November 27, 2013
Turning to a short idea, whats behind your pessimism about car-dealer Sonic Automotive [SAH]? BH: We know the auto-dealership business fairly well, having most recently had a big win investing in Lithia Motors [LAD], one of the five big, public players in the market along with Sonic, Asbury Automotive, AutoNation and Penske Automotive. Sonic is the third-largest, with around 110 stores in 14 states, and it gets more than 80% of its new-vehicle revenue from luxury or import dealerships. Compared to the competition, its growth and
INVESTMENT SNAPSHOT
profitability look relatively weak. Compstore sales over the past year have been growing in the double digits for Asbury, Lithia and Penske, but Sonics growth has been about 4%. Its EBITDAR margin, which includes rent, has been running at 3.6%, while Lithia and Asbury are both over 5%. That in our view makes Sonic more vulnerable to the stalling out we expect in auto sales domestically. New-car sales on a seasonally-adjusted basis have gone from less than 8 million to 16 million and growth from here strikes us as difficult. Interest rates are going up, making out-
Sonic Automotive
(NYSE: SAH)
Valuation Metrics
(@11/26/13):
Business: Third-largest auto dealership group in the U.S., with over 100 stores in 14 states. Significant majority of dealerships focused on luxury and import brands. Share Information
(@11/26/13):

(@9/30/13):
SAH Russell 2000 14.8 75.5 10.7 26.9 10.6
Price 23.16
Financials (TTM):
SAH PRICE HISTORY 30 30 25 25 20 20 15 15 10 10 2011 THE BOTTOM LINE
Company Fidelity Mgmt & Research BlackRock Vanguard Lombardia Capital Luther King Capital Shares Short/Float
% Owned 12.0% 6.4% 5.3% 5.0% 4.0% 12.5%

30 25 20 15 10
Clos
2012
2013
Given its lagging growth, relatively weak profitability and risky new pricing strategy, Bill Hench considers the company highly vulnerable to the stalling out he expects in domestic auto sales. If 2014 earnings come in at the $1.40 to $1.50 per share he considers possible vs. the consensus $2.20 he believes the stock can trade in the mid-teens.
the-door prices less attractive. Used-car prices seem to have peaked and are likely to pull back. We also think its a warning sign that more and more auto loans are being made to sub-prime borrowers. The company is also intent on pursuing a pricing strategy that has repeatedly not worked in the industry, namely more of a no-haggle model where prices are set at the corporate level and theres little leeway for negotiation. We suspect thats one reason for Sonics poor relative comp-growth performance. Its always difficult to stand out on your own, especially in such a competitive market where none of the other big dealerships are doing it. We just dont believe its going to work and that within six to nine months theyll revert to the old way of doing things. In the interim, we expect the pricing stance to have a negative impact on sales that isnt made up for in profitability. Sonic has announced another initiative to open stand-alone used-vehicle dealerships to compete with CarMax. Do you consider that a good idea? BH: I dont have a strong opinion. I do wonder why Sonic thinks this is such a good idea when the best competitors in their business dont. I was also surprised that they didnt plan to be involved in the financing of the used-car sales, which is a key way used-car dealers make money. In the short term its likely to be a distraction, but it isnt really something were betting on either way. What downside do you see in the shares from todays price of just over $23? BH: Consensus EPS estimates for this year are around $2 and for next year around $2.20. If comp-store sales remain weak, we think theres a good chance the company will miss the estimate for this year. If the pricing strategy falls flat in a growthchallenged market next year, wed expect earnings to fall materially, as profitability comes down pretty quickly when units drop. At todays forward multiple on something closer to $1.40 to $1.50 in
November 27, 2013
2014 EPS, youd have a share price in the mid-teens. Are you doing more selling than buying in todays market? BZ: In general, the buying opportunities are fewer and the upside in any particular name tends to be lower. But what makes the current environment particularly tricky is that its becoming more of a momentum market. True to their name, momentum buyers will continue to buy on the way up with no true value discipline. That means that those of us who do have a value discipline will leave plenty of money on the table in this kind of market. People over the years ask me what I think the stock market will do next year and I always say, The direction of the market will be determined by events that have not yet occurred. What we try to do is keep the valuations of the stocks in the portfolio at such a level that if there is a selloff, we have confidence that the stocks will ultimately recover and grow beyond where they are today. BH: Id add that in times like this you should pay more attention to companies that disappoint. A bad quarter can result
in a very swift and very sharp reaction in the share price. We are finding things to buy that have gone from fully priced to cheap from one day to the next. Youve done better in bull markets than bear markets, not typical of the average value investor. Why is that? BZ: One of the less-fortunate aspects of small-cap stock pricing is that there is no such thing as low. In the most-recent crisis I started buying the stock of one company that had $10 per share in cash, no debt, and breakeven cash flow in a recession. I bought some more at $8, at $7, at $5, and even at $3. It was absurd, but I guess it keeps things interesting. We invest very aggressively in weak markets, so oftentimes on the way down we have terrible performance. But when Im investing in a stock like the one I just mentioned, what does that mean? Where was my risk? In that particular case we kept our conviction and ended up selling at around $14. As I get older I become a little less emotional about it all. All you can do is make sound, rational decisions. Experience teaches you in the end that should be good enough. VII
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I N V E S T O R I N S I G H T : Broad Run
Investor Insight: Broad Run

Brian Macauley, David Rainey and Ira Rothberg of Broad Run Investment Management describe the quality standards that narrow their opportunity set, why they hold their average position for nearly seven years, how they try to limit unforced errors, and why they believe Aon, OReilly Automotive, American Tower and Diamond Hill are mispriced.
Youre at the high-quality compounder end of the value investors target spectrum. Explain what high quality means to you. Brian Macauley: In many ways its the standard definition: Were looking for businesses that have sustainable competitive advantages that enable them to earn outsized economic profits for a long time. The advantage can come from many sources, including scale, proprietary know-how, unique patents or licenses, high customer switching costs, high barriers to entry and low costs. We focus on companies with leading positions in their industries and on industries with secular growth drivers and a rational competitive dynamic. Ira Rothberg: Where we believe we put more emphasis than most is on risk avoidance. If you read Charles Elliss classic investment book, Winning the Losers Game, he likens investing to amateur tennis, where the victor prevails because he makes fewer unforced errors than his rival. The key to winning isnt going for the corners, but to consistently hit the ball back over the net. Our strategy is to own high-quality, modestly valued businesses over many years, to take advantage of the power of compounding as earnings grow. To do that successfully only works if we avoid mistakes unforced errors that interrupt the power of compounding. That means being acutely sensitive to rising competitive threats, technological obsolescence, faddish levels of demand, excess financial leverage and unsustainable valuation levels. The power of compounding is so great that our first job as investors is to avoid anything that might short-circuit it. BM: We apply a simple test to every business: can we reasonably predict what it will look like in ten years? The reality is that for most businesses the answer is no.
November 27, 2013
Thats a key way we narrow our universe and it goes a long way toward reducing our risk of permanent capital loss. What recent examples didnt pass the test? BM: One would be Dun & Bradstreet [DNB]. D&Bs credit reporting is a strong franchise with scale advantages and high margins. But its facing new competitive threats from established firms like Experian and Equifax, as well as upstarts such as Cortera. Our concern is that these new entrants can combine sophisticated analytics with Internet and alternatively sourced data to produce comparable information at a fraction of what D&B charges. A step-function decrease in rivals cost to compete would have big consequences for the high-margin incumbent. Another example is II-VI Inc. [IIVI], the laser component maker. We were attracted by the secular growth in the laser industry and the companys leading share and lowcost position in CO2-laser components. What kept us away was the improved functionality and declining costs of competing fiber-laser technology. Were confident the laser industry will have a larger role in manufacturing 10 years from now, but its just too hard to handicap how much of that market will be addressed by the CO2 lasers that II-VI relies upon. How did a technology company like Google [GOOG] pass the ten-year test when you bought it in early 2011? IR: When we purchased the stock it was trading for only 11x earnings, net of cash. Our view then and now is that Google, through the quality of its search function and by extending its tentacles through things like Gmail, the Chrome browser, Google Maps and Android, has created a customer habit that is unlikely to change.
I. Rothberg, D. Rainey, B. Macauley
First-Hand Knowledge
There was no need for big strategic or process changes when Brian Macauley, David Rainey and Ira Rothberg took over in 2009 for Chuck Akre [VII, December 28, 2011] in managing what is now the Hennessy Focus Fund. Says Rothberg: Charlie Munger in a recent interview with Fortune said, I have a habit in life, I observe what works and what doesnt work and why. So having observed Chuck and other value investors like Buffett and Munger with strong track records, were happy to copy what they do and make some of our own innovations. When you see something work first-hand, it obviously encourages you to keep doing it. There have been some changes at the margin. While concentrating on a small number of names as Akre did, the new team generally wont let one position exceed 10% of the portfolio and makes only one bet per industry, rather than two or three. Theyve also embraced a player/ manger organizational strategy, in which the three portfolio managers are the entire analyst team. In such a concentrated portfolio, each name needs to be right, or at least not significantly wrong, says Macauley. We think it makes sense to have three sets of eyes thinking very critically about how things could go wrong.
It invests so much in R&D to maintain search leadership that its hard to foresee a breakthrough it couldnt replicate before losing any material market share. It has 70% search market share in the U.S. and even higher overseas, shares that have been stable or growing for many years. Contrast that with the share and profitability shifts in markets like mobile phones. The one technology change that might have been a threat to Google has been the transition to mobile, but it has managed that transition very well and may be even more competitively strong there. What level of growth are you typically looking for? BM: We try to find companies that can grow intrinsic value per share three- to five-fold over 10 years, which implies a mid-teens level of annual growth. There are typically secular drivers or clear company-specific advantages behind this growth. In the case of American Tower [AMT], increasing penetration of smartphones is driving the need for more wireless capacity, both here and abroad. For Encore Capital [VII, May 31, 2013], credit-card debt collection isnt a growth industry, but changes in the industrys regulation and structure since the crisis are working to the companys advantage and have helped it sharply increase market share and earnings. To be clear, we very much consider ourselves value investors. But rather than the typical model of paying 50 cents for $1 of value, were willing to pay 80 cents for what we believe will be $3 to $5 of value down the road. Id add that were not looking for hyper growth, which usually brings higher uncertainty and valuation along with it. Well do well without incurring undue risk if we can pay a modest multiple for a business compounding at a mid-teens rate for five or ten years. Describe the traits you look for in top management. BM: We look for people who think like long-term owners and have skin in the
November 27, 2013
game. Were often investing where the founder or founding family is still active and/or the people in charge have spent the majority of their careers at the business. Because managements capital-allocation decisions have such an important impact on the value created over our expected five- to ten-year holding period, we pay careful attention to their historical record and want to hear that they have a rational framework for making such decisions. To give an example of what appeals to us, prior to the financial crisis OReilly
are unlikely to invest in biotech, medical devices, semiconductors and much of information technology. Were cautious as well in industries with big risks of customer concentration, such as healthcare, and in those with high governmental influence. David Rainey: We are active in consumeroriented businesses, business services, specialty financials and less-cyclical industrials. These are businesses that often require less labor and capital and therefore generate outsized profits and return on investment. There are roughly two dozen stocks in the portfolio today, but we also keep a watch list of about 75 names that meet our quality criteria but where the stocks are too expensive. In any given year three or four or five of those watch-list names get cheap enough for what we consider transitory reasons. Given our typical holding period, thats all we need. Do you have any market-cap restrictions?
ON LEVERAGE: We favor conservatism borne out of thinking about the long-term health of the business, not just profits today.
Automotive [ORLY] was getting pressure to improve near-term earnings per share by levering up to repurchase stock. The gentlemen at the helm had spent their entire careers at the company and had a longer-term vision, which included buying out a large competitor on the West Coast, CSK Auto. By preserving the companys balance sheet, they were able to buy CSK at a bargain price when it was in distress in 2008. OReilly did eventually start to aggressively repurchase shares, but only after it had digested the acquisition. Our businesses tend to have betterthan-average balance sheets, in part because the people running them dont feel the need to max out leverage at all times. Thats a conservatism borne out of thinking about the long-term health of the business, not just maximizing profits today. Is your opportunity set fairly narrow? BM: The 10-year test alone tends to limit where we look. We avoid natural resources, where the economic value is driven more by a commodity price than what the business itself is doing. We avoid businesses with rapid technological change, so
IR: Were market-cap agnostic, but its easier to find businesses that can be three to five times larger over the next 10 years among small- and mid-caps, which make up about three-quarters of our assets. We also like that these smaller names tend to have easier-to-understand businesses, less-complicated balance sheets and moreaccessible management. Were more likely to develop competitive insight around a smaller company than a big one. What we dont do is put any artificial constraints on the size company well own. We think its a mistake to have to sell something after it reaches a certain size. These are often the investments you know the best and that have compounded the most for you over time. To have to sell them for no other reason than size doesnt make sense to us. As an illustration of how something goes from idea to portfolio holding, describe one of your most recent purchases, of Micros Systems [MCRS]. DR: We got to know Micros over the years from investments weve made in the
hotel/casino industry, one vertical market in which it sells point-of-sale and enterprise-management software and systems. It had many traits we like leading market shares, high switching costs, high returns on capital, high margins but the stock never got off our watch list because it historically traded at a full valuation. The shares came under pressure in the middle of last year after a couple weak quarters, primarily due to a poor European hotel market and slow U.S.-restaurant capital spending. With growth grinding to a halt, people started to worry that a couple guys in a garage might develop an iPad app that makes Micros workstations and servers obsolete. At the end of the year, the long-time CEO announced he was stepping down, adding to the uncertainty. From the mid-$50s earlier in the year, the stock fell as low as $40. Our judgment was that the industry challenges were temporary, that technology threats were not material, that the new CEO brought a lot to the table, and that the company had an opportunity to resume growth by following its anchor clients into fast-expanding emerging markets. We bought a small position about 1% of assets in the fourth quarter of 2012, and then roughly tripled our stake in this years second quarter. [Note: Micros shares currently trade at $53.50.] How do you think about valuation? IR: Were essentially trying to pay a lowteens multiple of what Warren Buffett defined in his 1986 Berkshire Hathaway shareholder letter as owner earnings free cash flow before growth-related capital spending for businesses we believe can compound our capital at a mid-teens rate or better. If were buying a quality business at a discount multiple, we expect our return to at least mimic the companys growth in intrinsic value per share. Well do even better if we get a little multiple expansion along the way. Were cognizant of private-market multiples and where the business has traded relative to its own history and peer group, but wed argue theres a lot of false
November 27, 2013
precision in our business and that the best investments dont require a financial model that goes out five significant digits. The key is recognizing a fat pitch and swinging. When a business like Google trades at 11x earnings, your DCF model isnt going to be your competitive differentiator.
ON CONCENTRATION: In a given industry we wont scatter our capital around, instead selecting the one idea we think is best.
As with Micros, do you tend to take starter positions first? DR: Yes. The reality is that it can take years to know a business thoroughly. Every time you visit with management, talk to a competitor or just read about whats going on in an industry, you gain a deeper understanding of the business and the company. That either supports your longterm thesis or it doesnt. As we gain confidence in the thesis and get various pricing opportunities, were comfortable with positions that are 7-8% of the portfolio. In a portfolio with two dozen names, how do you manage diversification? BM: We try to strike a balance between concentration and diversification with 20 to 30 stocks spread across a wide range of industries. Of our 23 holdings today we have exposure, depending on your definition, to 21 or 22 industries. Also, in any given industry we wont scatter our capital around, instead selecting the one idea we think is best. Describe the thesis behind one of your largest current holdings, Aon [AON]. BM: Aons main business is insurance brokerage, helping corporate customers identify, remediate and insure against the risks in their businesses. Its secondary business,
scaled up through the purchase of Hewitt Associates in mid-2010, is focused on human-resources consulting and businessprocess outsourcing. There are several aspects of the business we like. Customers have a recurring annual need for Aons services and once on board they tend to stick around for many years. Both businesses are assetlight, requiring little cash investment to support growth. The insurance-brokerage industry has consolidated over the last two decades, and Aon is now the biggest of only three competitors capable of servicing Fortune 1000 customers on a global basis. Finally, we think CEO Greg Case is a very thoughtful capital allocator. We first got involved here in early 2010. Our thesis at that point was that this was an excellent business undergoing temporary pain from depressed insurance pricing, depressed insurance exposure units coming out of the recession, and depressed float income because of low interest rates. We considered buying into that at 9-10x owner earnings to be an attractive proposition. Since then the company has made steady progress in taking costs out of both the Aon and Hewitt businesses. The soft insurance market is now stable to slightly positive. The economic environment has gotten a little better, which helps insurance exposure units and also on the HR side. The stock has done well and now [at $82] trades at about 14.5x our $5.60 per share estimate of 2014 owner earnings. Is that still cheap given Aons prospects? BM: The elements of our original thesis are still playing out. The economy continues to slowly improve. Interest rates appear to have bottomed. As for the insurancepricing cycle, while theres still too much capital in the industry across the board, we expect that as companies run out of reserve releases theyre going to have to be more focused on underwriting profits to drive future earnings. We dont expect the big rebound in pricing weve seen in previous cycles, but a more gradual and persistent improvement.
With 4% annual revenue growth and improvements targeted in operating margins, we think EBIT can grow over the medium-term at 6-8% per year. Tax savings from redomiciling the company from the U.S. to U.K. should add another point to net earnings growth. They have about a 5% free-cash-flow yield which is used to pay a small dividend and aggressively buy back stock. Add that all up and you get a business compounding its value at 12-14% per year. Paying a 14.5x multiple for that is still an attractive proposition. What could make it much more attractive is if Aon has the success we believe
INVESTMENT SNAPSHOT
it can in private healthcare exchanges. These are exchanges set up for corporate customers that allow their employees and retirees to buy healthcare. Aon earns revenue as an operator primarily from commissions on policies placed. This is an early step on the road toward insurance becoming a defined-contribution benefit in much the same way pension plans gave way to defined-contribution 401(k)s in the 1980s. It offers a tremendous value proposition to the corporate customer and Aon is well positioned to leverage its existing capabilities to provide a compelling solution.
Is this a real business yet? BM: The target markets are the 45 million current employees and the 12 million retirees in the U.S. under large-corporation insurance plans. Right now Towers Watson has the leading retiree exchange, while Aon is #2 with around 100,000 participants. Aon has the #1 employee exchange, with over 600,000 lives covered. Its still very early, but penetration rates are growing rapidly. When we run the numbers, the retireeexchange market alone is a roughly $3 billion annual revenue opportunity, while the active-employee market is three to four times larger. That assumes this evolves as 401(k) plans did, which is obviously uncertain, but there are plenty of reasons to believe it will. We dont need any of this to find the stock attractive today, but its certainly a compelling option on the upside. OReilly Automotive has had a great run since the crisis. Why are you still a big fan? IR: The company is the second-largest distributor and retailer of aftermarket auto parts in the U.S. It serves both the retail do-it-yourselfer as well as the professional do-it-for-me markets, selling a wide range of products, from spark plugs and windshield wipers to transmissions and cylinder heads. We first got involved in 2005, attracted byClose a market that was ripe for consolidation and by the companys superior distribution model. OReilly has always invested heavily in its distribution infrastructure in order to offer better parts availability and faster delivery times, critical advantages in serving particularly the professional market. Given its sustainable advantages and single-digit market share in a huge industry, we thought it had ample room to grow. And as it grew, scale advantages in securing and distributing inventory would make the company more profitable and an even more-formidable competitor. DR: I should return briefly to our conversation about predicting what the business might look like in ten years. Miles driven
Aon
Valuation Metrics
(@11/26/13):
(NYSE: AON)
Business: Provider of insurance, risk-management and human-resources consulting and services, primarily to large enterprise clients, in more than 120 countries. Share Information
(@11/26/13):

(@9/30/13):
AON S&P 500 24.6 18.8 15.5 16.0 12.9
Price 81.87
Financials (TTM):
AON PRICE HISTORY 100 100
Company % Owned Eagle Capital Mgmt 5.0% Southeastern Asset Mgmt 4.8% State Street 4.7% Artisan Partners 4.7% Vanguard 4.3%
Shares Short/Float
0.9%
100
80 80
80
60 60
60
2012
2013
40
Through organic revenue growth, targeted improvements in operating margins, tax savings from a domicile shift, dividends and share buybacks, Brian Macauley believes the company can compound shareholders capital at 12-14% per year. If a fledgling healthcare-exchange business takes off, he says, that adds a compelling option on the upside.
November 27, 2013
in the U.S. is quite stable, even during recessions, and as long as people drive, auto parts will wear out and need to be replaced. This is true whether people are driving gasoline-powered, hybrid or electric cars. The independent Internet provider poses little threat because of the immediacy of the customer need. Our view is that the auto-parts business ten years from today will look pretty much the same. Whats driving company growth today? IR: OReillys current U.S. store count is around 4,100, but we think it ultimately can be closer to 6,000. That will come from expanding in new markets where the company is virtually absent, such as the Northeast and southern Florida, as well as from increasing penetration in existing markets, particularly those opened up with the CSK acquisition. Mom and pops, still about 50% of the overall U.S. store base, continue to be run out of business by consolidators like OReilly and AutoZone which have buying power. Overall, were expecting the companys annual square footage growth to be about 5%. Another key benefit should be continued improvement at the outlets acquired from CSK. At the time of the purchase, those stores were earning 3% operating margins and generating about $1.3 million in annual sales per store. Today their margins are in line with OReillys 16.5% overall level, and we estimate theyre generating more like $1.6 million in sales per store. As the distribution model continues to attract professional customers, we think that could improve to at least $2 million per store. Were also counting on margin improvement, both from operating leverage as the company grows and from a culture of expense control that is deeply ingrained. Just to give an example, when weve made trips into the field with management, the CEO and CFO will share a hotel room and stay in a much cheaper place than those of us in the investment community. We estimate that operating margins by 2015 can hit 18%, 150 basis points over todays level.
November 27, 2013
Are there secular market trends working for or against OReilly? IR: The average vehicle age in the U.S. has been increasing as people can hold onto cars longer because theyre better engineered. As cars get older they go through more frequent maintenance, which is good for the auto-parts industry overall. Another positive trend is the increased sophistication of todays cars, causing a gradual market shift from do-it-yourself to do-it-for-me. At the same time, the number of makes and models are increasing, driving higher parts counts. Both trends
INVESTMENT SNAPSHOT
favor OReilly its distribution intensity can better deal with both professional demand and a proliferation in parts. People worry that the rise in new-car sales will impact aftermarket-parts demand, but that hasnt really happened. Part of that is because the number of vehicles scrapped remains near historic lows even as new-car sales have increased. How are you looking at valuation with the shares recently trading at $124? IR: Assuming 5% annual square-footage growth, 4% growth in comp-store sales,
OReilly Automotive
(Nasdaq: ORLY)
Valuation Metrics
(@11/26/13):
Business: Supplier of automotive aftermarket parts, tools, supplies, equipment and accessories to both professional and do-ityourself customers in the United States. Share Information
(@11/26/13):

(@9/30/13):
ORLY S&P 500 21.6 18.8 18.5 16.0 11.6
Price 124.51
Financials (TTM):
ORLY PRICE HISTORY 150 150 120 120 90 90 60 60 30 30 2011 THE BOTTOM LINE
Company % Owned T. Rowe Price 7.4% Vanguard 7.0% State Street 4.4% Ruane, Cuniff & Goldfarb 3.4% BlackRock 2.7%
Shares Short/Float
4.4%
150 120 90 60 30
Clos
2012
2013
Ira Rothberg considers the company the best player in a still-consolidating industry that rewards scale. He expects increases in square footage, comp-store sales, margins and share buybacks to result in mid-teens annual EPS growth over several years. Given todays valuation, he believes shareholders return should match the growth in EPS.
margin improvement and stock buybacks, we expect EPS to grow at a high-teens rate over the next three years and at a midteens rate longer term. With the likely acquisition of another regional chain, that compounding would be even higher. For that were paying 17.5x our $7.15 per share estimate of 2014 owner earnings. Thats not a modest valuation, but fair and in line with what the market has paid historically for the stock. Given that, were comfortable that our shareholder return can match the growth in earnings per share, providing more than satisfactory upside from todays price. American Tower has attracted some naysayers of late. Why do you think the bull case is fully intact? DR: The company operates more than 60,000 cell sites in the U.S. and abroad, leasing space to wireless carriers such as AT&T and Verizon in the U.S. and Telefonica and American Movil overseas. These are relatively scarce assets with excellent long-term economics. Once a tower is sited, zoned and built, there is little economic reason for someone to put a tower right next to it. Theres space for multiple tenants, and each incremental tenant provides a very high profit contribution. In the U.S., the first tenant generates a highsingle-digit cash-on-cash rate of return on a tower, while by the fourth tenant it starts to look like an oil well. Once tenants are in place, its expensive and disruptive for them to leave. The U.S. tower industry has gone through a long period of consolidation, starting 10 to 15 years ago when the wireless carriers concluded their capital would be better deployed building out their networks and acquiring new customers than in owning underutilized tower assets. U.S. towers are now primarily in the hands of three independent players, American Tower, Crown Castle [CCI] and SBA Communications [SBAC]. A central element of our investment case is that the U.S. tower business is in a golden age that should last at least for the next five to ten years. All of the major
November 27, 2013
national carriers have reloaded their balance sheets and are building out their 4G networks on top of their existing 3G networks. 4G services new spectrum and requires completely different equipment on towers. Whether its Verizon and AT&T just now beginning to add density to their coast-to-coast 4G networks or Sprint and T-Mobile just beginning 4G builds, they will all require using incremental cell-tower space on which the tower operators are currently earning little to no revenue. On top of that you have the governments proposed national 4G network, called FirstNet, the first site for which will probably
INVESTMENT SNAPSHOT
get turned on next fall. If Charlie Ergen is successful in building out Dish Networks planned 4G network, the land rush will be even more intense. Is the story similar internationally? DR: American Tower for some time has been taking its excess U.S. capital and deploying it in developing markets like Mexico, Brazil, India and South Africa. We consider management very sophisticated in capital allocation, targeting markets with a rapidly growing middle class, heavy competition among a number of
American Tower
(NYSE: AMT)
Valuation Metrics
(@11/26/13):
Business: Develops, owns and operates more than 60,000 wireless and broadcast communications towers located in the United States and 12 foreign countries. Share Information
(@11/26/13):

(@9/30/13):
AMT S&P 500 53.1 18.8 35.0 16.0 19.5
Price 78.03
Financials (TTM):
AMT PRICE HISTORY 100 100
Company % Owned T. Rowe Price 8.7% Fidelity Mgmt & Research 5.0% Vanguard 4.8% State Street 4.3% BlackRock 4.3%
Shares Short/Float
1.8%
100
Clos
80 80
80
60 60
60
2012
2013
40
As relentless demand for global wireless capacity continues and it leases space on its communications towers at ever-higher incremental margins, the company can generate low-20% annual growth in owner earnings, says David Rainey. Without valuation compression from todays fair level, he says, shareholders would earn a comparable return.
wireless carriers, and where the U.S.-type outsourcing model is taking hold. Theyve taken criticism because certain markets, like India, havent developed as quickly as expected. People also seem worried that profitability outside the U.S. hasnt been uniformly high. If you look at the entire portfolio, however, we consider the international business to be doing quite well. We also believe the critics dont always see the forest from the trees. It is true when you buy a tower portfolio with a single tenant and pay a full price because of location, the initial returns can be modest. But once you add additional tenants, the rates of return move up like a hockey stick. Weve seen this play out in the U.S., and as long-term investors its a proposition we like overseas. Many of these markets are five to ten years behind the U.S. in terms of voice and data coverage. How do you see all this translating into revenue and profit growth? DR: Overall were looking for 12-13% top-line growth mid-teens or better internationally and high single digits in the U.S. Given the high incremental margins, particularly in the U.S., we believe totalcompany EBITDA should grow at a highteens rate and that adjusted funds from operations [AFFO] a good proxy for owner earnings can grow at a low-20s rate for the next three to five years. At a recent price of $78, can you expect earnings growth to translate into a comparable shareholder return here? DR: Basically, yes. The company should earn somewhere between $4.30 and $4.50 in AFFO in 2014, so the multiple isnt cheap at more than 17.5x. But we believe its a fair multiple given the revenue visibility, international growth prospects and the likelihood that management will continue to intelligently allocate capital. Are there technology-related risks of note? DR: There are other technologies, including Wi-Fi and small transponders that
November 27, 2013
can be attached to buildings in densely populated areas, that will help augment network coverage. But the coming data demand should swamp excess capacity, so we dont see any slowing of demand for highly cost-effective tower space. Describe why Diamond Hill Investment Group [VII, May 31, 2012] meets your quality standards. IR: When we look at an investment manager we concern ourselves with three things, philosophy, process and people. We think Diamond Hill scores very well
INVESTMENT SNAPSHOT
on all three. Its strategies are rooted in the teachings of Graham and Buffett, emphasizing fundamental research, margin of safety and a long-term investment horizon. That long-term view is reinforced by compensation, which is largely based on rolling five-year performance results. The company is run by investment people, not marketing people, and interests are well aligned with both clients who management emphasizes always come first and shareholders. Employees can only have equity exposure through Diamond Hill mutual funds, in which theyve invested more than $60 million, or in Dia-
Diamond Hill Investment Group

(Nasdaq: DHIL)
Valuation Metrics
(@11/26/13):
Business: Value-based investment manager serving individual and institutional investors in the U.S. Assets under management as of the end of September: $11 billion. Share Information
(@11/26/13):

(@9/30/13):
DHIL Russell 2000 19.3 75.5 n/a 26.9 13.3
Price 123.01
52-Week Range Dividend Yield Market Cap 66.30 123.50 0.0% $401.5 million $76.0 million 36.6% 26.6%
Financials (TTM):
DHIL PRICE HISTORY 150 150
Company % Owned Royce & Assoc 6.2% BlackRock 5.7% Wells Fargo 4.8% Akre Capital 4.5% Epoch Inv Partners 3.9%
Shares Short/Float
1.5%
150
Clos
120 120
120
90 90
90
2012
2013
60
The company has the potential to be a little T. Rowe Price, says Ira Rothberg, where a sound process, philosophy and culture translates into superior investment performance. Given the economics of the business, he expects shareholders to fare extremely well if assets under management, as he expects, double or triple within the next five years.
mond Hill common, in which they own 30% of the shares outstanding. Employee turnover has been very low. The results have been excellent. Seven of the companys eight strategies have since inception outperformed their benchmarks, while the management team, led by CEO Ric Dillon, has taken assets from $50 million in 2000 to $11.5 billion today. In keeping with a high-quality business, operating margins are over 35%. Why would a company like this not be lavishly valued by the market? IR: Performance over the last five years has only been average, primarily due to an overweight in energy. That has hurt net asset flows, which went flat in 2011, fell 3% in 2012, and were off 8% through September this year. From 2007 to 2010, net inflows averaged around 25% per year. Were counting on the philosophy, process and people here turning relative performance back up over time, and for net flows to again go strongly positive. Their relative investment performance has improved dramatically in the last 18 months, and flows are starting to turn positive. Just in the eight current strategies we think the asset capacity is around $30 billion. Theyre also laying the groundwork to launch global and international strategies, which would expand capacity further. How are you thinking about upside with the shares at a recent $123? IR: If you back out net cash and investments, the stock currently trades at 16.4x our $6.40 estimate of run-rate EPS. Here we dont go off forward earnings because theyre so dependent on the level of equity markets in any given year. We think 16.4x is a fair price if the companys performance and flows are in line with industry averages. But we actually expect them to be much better than that and that assets under management could be two to three times their current level within five years. Given the economics of the business, that makes the profit and share-price upside very interesting.
November 27, 2013
These guys have the potential to be a little T. Rowe Price, where the process, philosophy and culture translates into superior performance, which makes for an excellent asset-management business. Do you worry that a continuing rise in passive investing could crowd out fundamental stock-pickers like Diamond Hill? BM: These arent benchmark huggers they have high active share and a bottomup fundamental value discipline. If the
Whats a recent example of that? BM: We owned Lamar Advertising [LAMR] for several years and over that time downgraded our assessment of management due to sub-optimal capitalallocation decisions. We also became concerned that things like voice search and turn-by-turn GPS navigation on smartphones would help make mobile advertising a more significant competitor to Lamars outdoor advertising. That hasnt yet impacted the business, but its a secular risk were fearful will hit it in time. When the market got excited about the potential that Lamar would become a REIT, we decided there were better growth opportunities without the secular risks elsewhere. In fact, we used the proceeds to invest in Micros Systems, as well as in sporting-goods retailer Dicks Sporting Goods [DKS]. Can you generalize about your mistakes?
ON MISTAKES: I guess if you had to choose, errors of omission would probably be preferable to those of commission.
marketplace is more machine driven and there are fewer fundamental investors, Id expect that to create more opportunity for investors like Diamond Hill. Its the benchmark-hugging, low-active-share managers that will be in trouble the equivalent of Sears, say, squeezed between Wal-Mart and Nordstrom. As long-term owners, what generally prompts you to sell? IR: We expect most of our return to come from the compounding of intrinsic value rather than a return to intrinsic value. So were not quick to sell if something goes from 12x earnings to 16x earnings if we still believe theres a long runway for midteens type of compounding. That multiple difference isnt going to have a big impact on our total return. That said, if valuations get really extended, we sell. Our rough rule of thumb is that if we dont think were going to earn at least a 10% IRR on a name, wed rather hold cash. Frequently the reason we sell has more to do with concern that a companys moat is deteriorating or management has made bad decisions that havent yet hit the stock.
IR: Given the importance we place on not interrupting the power of compounding, we want our mistakes to be time-valueof-money mistakes and not permanentloss-of-capital ones. That has basically been the case our mistakes have almost always been those that didnt compound at our desired rate, not that lost money. Lamar would be an example, more or less a round-trip while it was in the portfolio. BM: We also think a lot about names we could have bought and just didnt due to risk aversion. In hindsight, many of those decisions have been costly. Visa and MasterCard are examples. We werent able to get comfortable with the potential impact of regulatory changes swirling around the duopoly. Another is LKQ Corp., an autoparts company that we stayed away from because of its potential legal liability in replicating design patents on vehicle parts. The stock is probably up 10-fold since we took a real hard look at it. I guess if you had to choose your mistakes, errors of omission would probably be preferable to those of commission. Weve been able to find other things to own that worked out fairly well. VII
S T R A T E G Y : Eric Rosenfeld
Taking the Bull by the Horns

The best activist investors are typically excellent fundamental value investors who also have a knack for making things happen. As a strategy, says Eric Rosenfeld of Crescendo Partners, thats unlikely to ever go out of style.
INVESTOR INSIGHT
Eric Rosenfeld Crescendo Partners On time horizon: We wouldnt stick around as long as we do if our intent was just to make a quick buck to the detriment of long-term value creation.
Editors Note: Right after #1 Elon Musk, Fortune in its latest ranking of the Top People in Business put as #2 The activist investor, explaining thusly: The worlds corporate leaders got a blunt warning this year: No company is too big or valuable to escape the threat of increasingly aggressive activist investors. For perspective on activists rising profile and impact, we put in a call to Crescendo Partners Eric Rosenfeld, one of the arts more experienced, though lower profile, practitioners. Targeting mostly small-cap companies in the U.S. and Canada, his latest in a series of funds has earned a net annualized 13.2% since it launched at the beginning of 2007, vs. 4.4% for the Russell 2000. In an interview, Rosenfeld and Crescendo Managing Director Gregory Monahan describe the opportunities they see over and over again, while also explaining the investment thesis behind their just-announced activist play in teen-retailer Aeropostale. Activists have to be good investors first. Describe where you look for ideas and the types of situations that tend to attract your attention.
November 27, 2013
Eric Rosenfeld: We target companies in the U.S. and Canada with market caps between $100 million and $3 billion, a capsize range where weve been more likely to identify undervalued companies and where there is more need and opportunity to push for change. Much of our idea generation looks like anyone elses, from our experience in following companies and industries, to our running valuation screens on things like enterprise value to free cash flow. But we also get a lot of ideas more specific to our expertise as activists. That could be from company directors with whom weve served previously on boards. It could be from analysts who may or may not have the best read on whats truly undervalued, but can have a very good sense of where shareholders are unhappy, which is quite important to us. Another common source is other value investors, who are frustrated that the value they see in a company is not being recognized and look to us to be a potential catalyst. There are five major categories of opportunity that we see over and over again, regardless of the industry. The first is poor management, which comes in a variety of forms. One is the evil CEO, who appears to be using the company as his or her piggybank and sees shareholders as an impediment to personal wealth creation. In 2008 we ran a proxy fight against Charming Shoppes, the largest retailer of plus-size womens clothing. The CEO had been there for 12 years, a period over which the stock did not move while the S&P Retail Index had gone up something like 250%. The company had fairly recently made a $200 million acquisition of a mail-order food retailer you can wonder about the synergies there with a plus-size womens apparel chain which it wrote down by $100 million a year later. Despite zero performance, the CEO had made over $40 million in the four years before we got involved.
We ended up getting board seats as a result of the proxy fight and six weeks after the shareholder vote the board unanimously decided to fire the CEO. It took someone from inside the boardroom to stand up and say the emperor had no clothes. As evidenced by the fact that this particular CEO had been there for 12 years, that does not always happen without intervention. Another common form of bad management is the entrepreneur who starts the company and is great at running a $25 million or $50 million company, but running a $250 million or $500 million company is beyond his or her skill set. We often also see the Peter Principle in action. Someone keeps getting promoted and finally reaches his level of incompetence when named CEO. Again, these are cases where top management needs to be replaced and we see the chance to get involved and make that happen. The second major category of opportunity is when strategic or operational mistakes are dragging the company down. Here a good example would be Cott Corporation [COT], the largest privatelabel beverage maker in the world. It for decades had a great business producing house-brand sodas for big retailers, but a new CEO named in the mid-2000s sold the board on a new strategy to make more branded drinks, which he said would double profit margins. He built up overhead, moved the headquarters from Toronto to Tampa and started competing with his customers. One new product they launched was FortiFido, water for your dog with vitamins and minerals added to it. It came in four flavors, including mint and peanut butter. Putting aside how good an idea that was, the problem was that Cott was no longer taking ideas to long-time customers like Wal-Mart, but was instead deciding to do things themselves. After the stock had fallen from $16 to $3, we bought 8% of
the company and negotiated for four seats on the board. The CEO was replaced and job number one was going back to the previous strategy, which has so far been well executed. We exited our stake in 2011 when the shares were around todays price of $8.50. Before continuing, two quick questions: Do you always try to get on the boards of companies you invest in, and how long to you tend to hold positions? ER: We will make more-passive investments where we dont seek board representation, but our typical goal for any active investment is to be on the board and look to bring out value. Over time weve tried to get on 22 boards and have been successful in 20 of those cases. Where we werent successful, the companies in both cases were sold within two years. The attempts themselves highlighted the value that was there. In terms of holding period, our historical average has been just over three years. People criticize activists for just trying to make a quick buck to the detriment of long-term value creation. We wouldnt stick around as long as we do if that were our intent.
Whats your next reliably common category of opportunity? ER: This is something value investors often find interesting, which is when a bad division is masking the value of the good ones. Whether the bad division gets much better or whether it goes away, the result is often an increase in recognized value. A classic example is Dalsa, a small technology company that when we got
ON BOARD MEMBERSHIP: Our goal in any active investment is to be on the board weve tried to get on 22 and been successful 20 times.
involved had two good businesses, in digital imaging and in specialty semiconductors. The problem business was trying to transform the production of major motion pictures with a digital camera that was meant to replace traditional film cameras. The company kept expecting the business to break through but it just wasnt happening. So you had two divisions making a total of $1 per share and one losing 25
cents per share, with the whole company valued on 75 cents in earnings. The stock price was stuck between $7 and $8 and shareholders were unhappy. We bought 10% of the company, negotiated three out of eight board seats and the board decided to get out of the movie business. What can happen in these situations is that not only do the losses go away, but energy and capital also gets refocused on building the remaining successful businesses. That happened in this case and Dalsa eventually was acquired by Teledyne for $18.25 a share. Does you current investment in Com Dev International [CDV:CN] have similar multi-division origins? ER: Its a bit different. Com Dev has two main businesses, the legacy one selling communications-related equipment to satellite manufacturers, and a new one called exactEarth, which is a satellite-based system that provides global vessel tracking and maritime monitoring to both commercial and governmental clients. We announced in the fourth quarter of last year that wed taken a more than 9% position in the company, and in this case one of the key reasons was that we didnt believe the market was ascribing the proper value to the exactEarth division, which was growing rapidly but hadnt yet broken even. The company announced last quarter that it just turned profitable. We now have three seats on the board so Im limited in what I can say, however when we join any board our nominees continuously work with the rest of the board to evaluate what can be done to enhance both short- and long-term shareholder value. [Editors Note: Com Dev shares at a recent price of just under C$4 are up 25% so far this year.] The next category we find interesting is companies with the wrong capital structure, preferably one that has too much cash to one that has too much debt. In many cases the cash is trading at a discount to its value because shareholders are afraid the company is going to overpay for an acquisition and destroy value.
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November 27, 2013
Here our play is to prompt a refinement of the capital-allocation process, with an eye toward returning capital to shareholders and making sure that any acquisitions are held up against purchases of the companys own stock. You know your own company better than anything you might buy if buying shares back is cheaper, thats what you should do. Were assuming your last category reflects at least part of the opportunity you see in teen-retailer Aeropostale [ARO], a new investment on which you just went public. ER: It does. These are cases in which you just conclude the company should be sold. It may be that the industry is consolidating and the best way to realize value is through a sale. Or, as in the case with Aeropostale, what the company needs to accomplish would be better done as a private company. Walk through that and the broader case for Aeropostale. Gregory Monahan: The company is currently in the process of trying to turn itself around. The big problem for it and other mall-based teen retailers like Abercrombie & Fitch and American Eagle has been the rise of fast-fashion competitors like Zara, Forever 21 and H&M. Aeropostale has always been about the basics, but the basics are no longer fashionable. That trend has hurt it the most. Over the past five years, Aeropostale stock is up less than 10%, while American Eagle is up 125% and Abercrombie & Fitch is up 150%. In response, the company is going through an evolution in its product mix, saying it wants 50% of its products to be more fashion-forward. It is also cutting back on its overbuilt store base, planning to close down at least 100 of its 975 Aeropostale stores. Were guessing you consider those efforts insufficient. GM: Thats part of it. Weve been involved with a fair amount of retailers in the past
November 27, 2013
and typically weve hired third-party consultants to come in and analyze the full supply chain and all variable and fixed costs. The result especially in companies that have gone through a long period of growth is usually the identification of a ton of cost-saving opportunities that management didnt originally see. We expect that to be the case here. Beyond that, though, we believe that a turnaround like this in the retail sector is best executed as a private company. Closing stores, laying people off and changing managers garners much more attention in public companies, which doesnt rest easy
INVESTMENT SNAPSHOT
with suppliers or customers. Management may also not be as aggressive as they should for fear of disappointing investors expecting growth. All of this makes the turnaround that much harder. The letter you sent last week to the Aeropostale board was fairly critical of the companys capital allocation. Can you summarize your concerns? GM: Over the past five years the company has bought back $580 million worth of stock at an average share price of $22.75. We assume the boards expectation was
Aeropostale
(NYSE: ARO)
Valuation Metrics
(@11/26/13):
Business: Mall-based specialty retailer of casual apparel and accessories targeted primarily at American teens and tweens, both male and female. Share Information
(@11/26/13):

(@9/30/13):
ARO Russell 2000 n/a 75.5 n/a 26.9 8.2
Price 10.03
52-Week Range Dividend Yield Market Cap 7.78 17.10 0.0% $786.0 million $2.31 billion 0.8% (-0.9%)
Financials (TTM):
ARO PRICE HISTORY 30 30 25 25 20 20 15 15 10 10 5 5 2011 THE BOTTOM LINE 2012
Company Fidelity Mgmt & Research Tiger Consumer Mgmt BlackRock Wellington Mgmt Eminence Capital Shares Short/Float
% Owned 14.8% 8.2% 7.3% 5.8% 5.4% 34.4%

30 25 20 15 10 5
Clos
2013
The operational turnaround necessary at the company to reconfigure its product mix and cost structure would be better accomplished in private hands, says Gregory Monahan. Based on his assessment of the multiple of sales or of normalized EBITDA on an enterprise-value basis that a buyer would pay, he believes the shares are worth $14 to $16.
that the share price would increase based on improved performance, which has hardly been the case. [Note: ARO shares closed recently at $10.] While the company has been buying stock using stockholders money, the board and management have been more cautious with their personal wealth. Over the past five years theyve purchased no stock on the open market. What do you think the company is worth in a sale? GM: Based on our experience, were confident it could be sold for 0.5x to 0.6x sales, net of cash on the balance sheet. On consensus revenue estimates of $2.15 billion, that would imply a purchase price of between $14 and $16 per share. Thats also consistent with a 5.5x to 6.5x multiple of normalized EBITDA on an enterprise value basis. We think our $195 million estimate of normalized annual EBITDA is conservative, as it assumes EBITDA mar-
gins only get back to 9-10%, well short of the nearly 14% average over the past ten years. For those who would still argue for trying to turn the company around first before selling, wed say that if you can get $14-16 per share today, the executional
ER: I cant go into everything were currently doing, but there is a window open in January and February to nominate directors, which we intend to do. The shareholder vote, if the timing is consistent with this past year, would happen sometime in June 2014. Activist investing would seem to be at highs in terms of both impact and acceptance. Why do you think that is? ER: Twenty years ago the view among most institutions was that if you didnt like what was going on at a company whose stock you owned, there was nothing to do about it other than to sell. Activists have had success in proving that wasnt the only option, which has emboldened more investors to try it and more institutional owners to support it. There will always be bad actors and people who arent very good at it, but as activism continues to prove useful in unlocking value, its clearly here to stay. VII
ON ACTIVISMS RISE: Activists have had success in proving that selling wasnt the only option if you didnt like what was going on.
risk involved in a turnaround isnt worth it. If you assume a discount rate of 12%, which isnt unreasonable, the stock would have to double from todays price over the next three years just to match $15 per share in your pocket today. Youve written your letter. Whats next?
November 27, 2013
U N C O V E R I N G V A L U E : Pulse Seismic
Beneath the Surface

Energy-services firm Pulse Seismic has a beautiful business model, marred only by the volatility of its customers capital-spending budgets. But therein lies investment opportunity, says Emerging Value Capitals Ori Eyal.
In checking the boxes on what constitutes a high-quality business, Pulse Seismic would rate very well. The company licenses seismic data to energy companies that need it to assess the exploration potential of targeted geographic formations in western Canada. Customers highly subsidize the initial collection of data, which Pulse then owns. Its rarely economic for competing data sets to be built in a given geography. Theres no expiration date on the data collected, so Pulse can license the same data over and over for decades at virtually 100% incremental margins. With essential data that is exclusive to an area, and with the cost of seismic data accounting for only some 5% of the total cost of drilling, pricing power is high. At the same time, overhead costs are low the company generated C$86 million in revenue last year with 30 employees. Where Pulse lags on the quality spectrum is in the highly cyclical nature of its business, tied primarily to what customers are spending to explore for oil and natural gas. In a weak market for energy capex in Canada, the companys revenues have fallen nearly 40% year-to-date through September 30, while EBITDA is off 65%. Net profits in part due to rapid amortization of survey costs after a heavy period of data collection look even worse, resulting in a loss so far this year of more than C$16 million. But therein lies investment opportunity, argues Ori Eyal of Emerging Value Capital Management. He ignores Pulses reported earnings number, focusing instead on free cash flow that he calculates as operating income before amortization of the data library, less data-collection reimbursement from customers and maintenance capital spending. On this metric, at close to what he considers a cyclical trough, he estimates the company will generate some C$20 million in free cash this year. The real opportunity, however, arises in a more normal energy-price environment,
November 27, 2013
particularly for natural gas. Taking into account a 2010 acquisition that roughly doubled the size of Pulses seismic-data library, he estimates the companys normalized not peak annual free cash flow is closer to C$40 million. Against todays market capitalization of C$240 million, that would translate into a free-cash-flow yield of 17%. What are the shares more reasonably worth? At more welcoming points in the capex cycle, Eyal says the company and similarly situated service firms have traded for 10x free cash flow. If his cash-flow
INVESTMENT SNAPSHOT
estimates prove right, that would translate into a $400 million market cap for Pulse, nearly 70% above todays level. In the meantime, hes content with an effective annual shareholder return of around 6%, one-third from dividends and the rest resulting from Pulse continuing to buy back roughly 1% of its shares per quarter. In general, he considers the companys capital allocation, under the watchful eye of board chairman and large shareholder Robert Robotti of Robotti & Co. [VII, August 31, 2011], as good as Ive ever seen. VII
Pulse Seismic
(Toronto: PSD:CN)
Business: Collects, markets and licenses 2D and 3D seismic data used primarily in the exploration and development of oil and gas resources in western Canada. Share Information
(@11/26/13, Exchange Rate: $1 = C$1.046):
Financials (9 mo. ending 9/30, annualized):

Revenue EBITDA Margin Net Profit Margin
Valuation Metrics
(Current Price vs. TTM):
C$47.9 million 45.0% (-45.2%)
Price C$3.98
52-Week Range Dividend Yield Market Cap C$2.48 C$4.43 2.0% C$241.0 million
P/E
PSD:CN Russell 2000 n/a 75.5
PSD:CN PRICE HISTORY 5 5 4 4 3 3 2 2 1 1 2011
5 4 3 2 1
Clos
2012
2013
THE BOTTOM LINE
With its business near a cyclical trough due to weakened energy-exploration capital spending in Canada, the company should still earn a free-cash-flow yield this year of nearly 17%, says Ori Eyal. At a more normalized level of free cash flow, he would expect the stock to be valued at closer to C$6.60 per share, two-thirds above todays level.
EDITORS LETTER
Je Ne Regrette Rien
One of the less-pleasant aspects of being a value investor is an almost constitutional inability to fully enjoy market prosperity. While other investors find it easier to revel in the current seemingly inexorable rise in stock prices, the list of worries is long for those with more of a value bent. The stock you sold at full value is now worth 50% more. The idea you passed on six months ago because it was a dollar too expensive is up 75%. Your bargain stocks may be up, but doesnt everything else seem to be up a lot more? You tell yourself that the cash youve been stockpiling is dry powder, but at the moment its dead weight on your portfolio. If part of your strategy involves shorting ugh. After attending a tribute to French torch-song diva Edith Piaf whose bestknown recording, Je Ne Regrette Rien (I Regret Nothing), became a rallying cry for the French Foreign Legion Mariko Gordon of Daruma Asset Management started to ruminate about her own bullmarket regrets and the difficulties facing value investors in a market like todays. As she describes in her most recent investor newsletter: Most days youre faced Value Investor Insight is published monthly a with either loading down the portfolio with broken-down junk that, while cheap, doesnt represent real value and will sink further, or [loading up on] stocks that have gone parabolic [and face] multiple compression when the inevitable market meltdown happens. Channeling her inner Edith Piaf, Gordon acknowledges the importance of learning from the past, but advises quickly moving past it: If you cant shake off defeat, your confidence and judgment will suffer. She also describes the key ways in which she tries to keep the hounds of bullmarket frustration at bay:
I work on what look to be great businesses, regardless of valuation, figuring that one day we may get our chance. I look to see which insiders are buying their stocks, because most of the rest are now selling faster than you can say hot potato. I look to see where theres a management change, because maybe the force will be strong with them, and a pieceof-junk business will start to deliver and the stock will levitate. And most important of all, every day, without fail, as sacred to me as a bedtime prayer, I think of the following advice: One morning, years ago, I scrambled down the subway steps only to find the train leaving the station a pissed off woman cursing up a storm and a homeless guy sitting on a bench. After watching the temper tantrum unfold for a minute, the guy finally said: Lady, relax. Trains are like men. Another one will come along. So whenever I think of Piaf songs and of the frustration of the hot stock that got away in this bull market, I remember that patience is needed to get over those heartbreaks. Because another new idea, like trains and men, will be sure to come along soon.
Sound advice indeed. couldnt have sung it better.
Edith
VII
Piaf
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November 27, 2013
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November 27, 2013

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ValueInvestor

November 27, 2013

The Leading Authority on Value Investing

Other companies in this issue:

Investor Insight: Royce Opportunity

% Owned 12.0% 5.4% 5.2% 4.1% 3.9% 8.7%

Short Interest (as of 10/31/13):

15 15 2011 THE BOTTOM LINE

Value Investor Insight 4

Value Investor Insight 5

RTI International Metals

P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

RTI Russell 2000 39.4 75.5 24.6 26.9 9.8

Largest Institutional Owners

% Owned 14.9% 10.4% 8.7% 8.4% 6.6% 13.7%

Short Interest (as of 10/31/13):

Value Investor Insight 6

P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

SAH Russell 2000 14.8 75.5 10.7 26.9 10.6

Largest Institutional Owners

% Owned 12.0% 6.4% 5.3% 5.0% 4.0% 12.5%

Short Interest (as of 10/31/13):

Value Investor Insight 7

Or call toll-free: 866-988-9060

Value Investor Insight 8

Investor Insight: Broad Run

I. Rothberg, D. Rainey, B. Macauley

P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

AON S&P 500 24.6 18.8 15.5 16.0 12.9

Largest Institutional Owners

40 40 2011 THE BOTTOM LINE

November 27, 2013

P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

ORLY S&P 500 21.6 18.8 18.5 16.0 11.6

Largest Institutional Owners

Value Investor Insight 13

P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

AMT S&P 500 53.1 18.8 35.0 16.0 19.5

Largest Institutional Owners

40 40 2011 THE BOTTOM LINE

Value Investor Insight 14

Diamond Hill Investment Group

P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

DHIL Russell 2000 19.3 75.5 n/a 26.9 13.3

Largest Institutional Owners

60 60 2011 THE BOTTOM LINE

Value Investor Insight 15

Taking the Bull by the Horns

Or call toll-free: 866-988-9060

November 27, 2013

P/E (TTM) Forward P/E (Est.) EV/EBITDA (TTM)

ARO Russell 2000 n/a 75.5 n/a 26.9 8.2

Largest Institutional Owners

% Owned 14.8% 8.2% 7.3% 5.8% 5.4% 34.4%

Short Interest (as of 10/31/13):

Value Investor Insight 19

November 27, 2013

Value Investor Insight 20

Beneath the Surface

Financials (9 mo. ending 9/30, annualized):

C$47.9 million 45.0% (-45.2%)

PSD:CN Russell 2000 n/a 75.5

PSD:CN PRICE HISTORY 5 5 4 4 3 3 2 2 1 1 2011