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The Best of The S&A Digest
Saturday, September 20, 2008

It was always a hard question to answer...
 
Porter, love your letters from the "chairman" of GM. But if you're so sure GM is heading for an unavoidable bankruptcy, why does Mason Hawkins (one of the most respected value investors in the world) own nearly 10% of the stock?
 
Last week, Mason Hawkins filed paperwork with the SEC showing that he's sold every single share of General Motors common stock owned by the various funds (including Longleaf) he manages. As recently as June 30, Hawkins owned 44.7 million shares of GM, purchased at an average price of more than $60.
 
Assuming he sold the position last month, he probably got about $10.50 for his stock – suggesting a billion-dollar loss over 10 years. (These losses would have been mitigated by the spinoff of Hughes Electronics and the dividends paid out by GM along the way.)
 
Hawkins replaced his GM stock with a large position in GM senior convertible bonds, which yield more than 12% and can be converted into 13.2 million shares of GM stock, if the shares rise above $64.90. While Hawkins may still believe in GM's ability to avoid a financial collapse, he has certainly hedged his bets considerably: His bonds are safer to own in bankruptcy than the common stock, which will surely be wiped out.
 
 GM's senior management could teach classes on denial. Said the company spokeswoman about the news that GM's third-largest and highest-profile owner had sold his entire common-stock position, "The convertible bond purchase showed continued confidence in the company." Yes, confidence you're going bankrupt.
 
I asked our bond expert, Mike Williams, editor of True Income, to comment on Hawkins' switch from GM common stock to GM bonds. Says Mike:
 
Hawkins' firm Southeastern used to have a great reputation as a deep value player. But the move into GM bonds smacks of desperation. I am not sure the convertible bonds give him a better position in bankruptcy.
 
The legacy costs, especially the pension and retiree benefits, will accelerate and vest in a bankruptcy, and may stand in front of him. If these pension liabilities get assumed by the federal Pension Benefit Guaranty Corp., it will be extremely aggressive in asserting its rights.
 
The thing is bankrupt and they just don't know it yet. Better to not own any of it until it starts to smell bad. Then there may be opportunities.
 
Mike knows more about the bond market than any analyst we've met... He's been in the industry for 35 years and was buying and selling bonds before I was born.
 
So he knows how to tell the good from the bad. And he's found several safe ways for readers to make big, triple-digit gains in fixed income – something most people believe is impossible.
 
From a reader: Why is it that so many "value investors" seem to be unable to tell the difference between value and crap?
 
That's a great question. And I can't answer for anyone else. But for myself, I've avoided a lot of these situations by looking carefully at two accounting items...
 
First, I measure the value of a business by looking at its market cap plus all of its net debt. After all, that's the price you'd actually pay if you were to buy the entire company. That keeps me away from any company with lots of debt.
 
Second, I pay a lot of attention to a company's return on assets. Lots of crappy businesses (like securities dealing) dress themselves up with debt, which allows them to make good profits despite having a lousy core business. Consider Goldman Sachs: This most respected Wall Street firm earns less than 1% annually on its assets. Less than 1%. That's not a business, that's a pipe dream.
 
Why in the world would you operate your business in a fashion that ensures you can't survive a credit crunch? If you know anything about financial history, you ought to know a severe credit crunch happens about once every 20 years. Credit crunches seem like something you ought to plan for and be ready to take advantage of, instead of something that surprises everyone.
 
How should you take advantage of the situation? As I've written all year, by buying up shares of super high-quality businesses, with ironclad balance sheets. I can tell you buying shares of Verizon (VZ) at these prices is almost a one-way bet.
 
I've got several similar opportunities in my PSIA portfolio. I continue to believe our highest-rated stocks offer truly excellent long-term prospects. And at these prices, I wouldn't hesitate to establish meaningful positions in a handful of the world's best companies. 
 
Regards,
 
S&A Research




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