Monday, March 23, 2009

Distressed Investing with 3 of the Guru 5

A lengthy but excellent article comparing Americredit to Clayton homes appeared in SeekingAlpha recently.

Written by Sumit Shah, a writer we've never heard of but hope to read more from, the article even used the term "outside passive minority investor"--which is how Marty Whitman refers to "regular" stock investors in two of his great but little-read books. (Call us impressed!) Here's the beginning of the article:

The goal of the value investor is to identify investments where there is a potential for earning outstanding returns over time with little to no risk of permanently losing one’s capital. Such investments are relatively rare when considering the entire universe of publicly traded equities, and outside passive minority investors usually have to scour the stock market to find companies that trade at deep discounts to intrinsic value and that have attractive risk profiles.

Usually, the securities that meet these criteria trade at such deep discounts because they are misunderstood or underappreciated by the marketplace, but sometimes securities that appear to be misunderstood are trading at depressed levels for legitimate reasons – because the underlying companies are at risk of going into default or, even worse, into bankruptcy.

Distressed equity securities are usually too difficult for most ordinary investors to handle, and the majority of outside passive minority investors would be well-advised to stay clear of such companies unless they are extremely confident that they will not lose their principal in the case of bankruptcy, run-off, or, in times like these, receivership or nationalization.

Deep-pocketed outside investors or control investors, on the other hand, enjoy quite a different position than ordinary investors, as they can try to influence a distressed company’s restructuring process, implement turn around plans, invest new capital into the company, or in some cases acquire the troubled company at an extremely low price.

Warren Buffett has often stated that he tries to purchase great businesses trading at fair prices, but Buffett, unlike many investors, also often has the opportunity to acquire distressed companies that could be great businesses under different circumstances, and that are trading at great prices.

Last year, for example, Berkshire’s MidAmerican Energy subsidiary made a bid for Constellation Energy (CEG) that was so low it would have effectively been stealing the company had another bidder not appeared. Buffett was able to make such a lowball bid because Constellation had severe liquidity issues, and Berkshire (BRK.A) was offering Constellation an immediate cash infusion that would have enabled the company to avoid filing for bankruptcy protection.

Deep-pocketed value investors such as Bruce Berkowitz’s Fairholme Fund and Leucadia National (LUK), the conglomerate run by Ian Cummings and Joseph Steinberg, are at their best when they are able to find distressed investment opportunities like the ones Buffett enjoys. Fairholme and Leucadia have found just such an opportunity in their investment in AmeriCredit (ACF), an auto finance company that operates primarily in the subprime space.

To understand what they see in AmeriCredit, it is important to recognize that Berkowitz, Cummings, and Steinberg – some of the shrewdest investors out there – are huge Buffett admirers and have probably learned a great deal from closely following his deal making.

Indeed, their investment in AmeriCredit has many similarities to Buffett’s acquisition of a manufactured housing company called Clayton Homes in 2003, which Buffett discussed at length in this year’s annual letter to the shareholders of Berkshire Hathaway. It would be instructive to discuss Buffett’s acquisition of Clayton Homes to understand the opportunity Fairholme and Leucadia see in AmeriCredit and also to learn some useful lessons about subprime lending and securitization along the way...

If you're not intrigued by that lead-in, you're in the wrong place. You can read the rest at SeekingAlpha or at Sumit Shah's website. (Note: I added a handful of paragraphs to make the above more readable in the different format.)

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