T2 Partners Slides-5!3!11

8/6/2019 T2 Partners Slides-5!3!11

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An Overview of Behavioral Finance and

the Economy, What Worries Us, Our View

of the Market, and Some Stock Ideas

May 3, 2011


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T2 Partners Management L.P.

Manages Hedge Funds and Mutual Funds

and is a Registered Investment Advisor

The General Motors Building

767 Fifth Avenue, 18th Floor

New York, NY 10153

(212) 386-7160

[email protected] www.T2PartnersLLC.com


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Disclaimer

THIS PRESENTATION IS FOR INFORMATIONAL AND EDUCATIONALPURPOSES ONLY AND SHALL NOT BE CONSTRUED TO CONSTITUTEINVESTMENT ADVICE. NOTHING CONTAINED HEREIN SHALL CONSTITUTEA SOLICITATION, RECOMMENDATION OR ENDORSEMENT TO BUY ORSELL ANY SECURITY OR OTHER FINANCIAL INSTRUMENT.

INVESTMENT FUNDS MANAGED BY WHITNEY TILSON AND GLENNTONGUE OWN STOCK IN MANY OF THE COMPANIES DISCUSSED HEREIN.THEY HAVE NO OBLIGATION TO UPDATE THE INFORMATION CONTAINEDHEREIN AND MAY MAKE INVESTMENT DECISIONS THAT AREINCONSISTENT WITH THE VIEWS EXPRESSED IN THIS PRESENTATION.

WE MAKE NO REPRESENTATION OR WARRANTIES AS TO THE

ACCURACY, COMPLETENESS OR TIMELINESS OF THE INFORMATION,TEXT, GRAPHICS OR OTHER ITEMS CONTAINED IN THIS PRESENTATION.WE EXPRESSLY DISCLAIM ALL LIABILITY FOR ERRORS OR OMISSIONS IN,OR THE MISUSE OR MISINTERPRETATION OF, ANY INFORMATIONCONTAINED IN THIS PRESENTATION.

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS AND

FUTURE RETURNS ARE NOT GUARANTEED.3


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An Overview of Behavioral Finance

(further links on this topic are at:

www.tilsonfunds.com/behavioral_finance.php)


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What is Behavioral Finance?

Peter Bernstein in Against the Gods states that the evidence reveals repeatedpatterns of irrationality, inconsistency, and incompetence in the ways humanbeings arrive at decisions and choices when faced with uncertainty.

Behavioral finance attempts to explain how and why emotions and cognitiveerrors influence investors and create stock market anomalies such as bubbles

and crashes.

But are human flaws consistent and predictable such that they can be: a)avoided and b) exploited for profit?

Why is behavioral finance important?

Investing is not a game where the guy with the 160 IQ beats the guy with the130 IQOnce you have ordinary intelligence, what you need is thetemperament to control the urges that get other people into trouble ininvesting. -- Warren Buffett

5


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Common Mental Mistakes

1) Overconfidence

2) Projecting the immediate past into the distant future3) Herd-like behavior (social proof), driven by a desire to be part of the crowd or an assumption that the crowd is

omniscient4) Misunderstanding randomness; seeing patterns that dont exist5) Commitment and consistency bias6) Fear of change, resulting in a strong bias for the status quo7) Anchoring on irrelevant data8) Excessive aversion to loss9) Using mental accounting to treat some money (such as gambling winnings or an unexpected bonus) differently

than other money10) Allowing emotional connections to over-ride reason11) Fear of uncertainty12) Embracing certainty (however irrelevant)13) Overestimating the likelihood of certain events based on very memorable data or experiences (vividness bias)14) Becoming paralyzed by information overload15) Failing to act due to an abundance of attractive options16) Fear of making an incorrect decision and feeling stupid (regret aversion)17) Ignoring important data points and focusing excessively on less important ones; drawing conclusions from a

limited sample size18) Reluctance to admit mistakes19) After finding out whether or not an event occurred, overestimating the degree to which one would have predicted

the correct outcome (hindsight bias)20) Believing that ones investment success is due to wisdom rather than a rising market, but failures are not ones

fault21) Failing to accurately assess ones investment time horizon22) A tendency to seek only information that confirms ones opinions or decisions23) Failing to recognize the large cumulative impact of small amounts over time

24) Forgetting the powerful tendency of regression to the mean25) Confusing familiarity with knowledge

6


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Overconfidence

1) 19% of people think they belong to the richest 1% of U.S. households2) 82% of people say they are in the top 30% of safe drivers3) 80% of students think they will finish in the top half of their class4) When asked to make a prediction at the 98% confidence level, people are right only

60-70% of the time5) 68% of lawyers in civil cases believe that their side will prevail6) Doctors consistently overestimate their ability to detect certain diseases

7) 81% of new business owners think their business has at least a 70% chance ofsuccess, but only 39% think any business like theirs would be likely to succeed8) Graduate students were asked to estimate the time it would take them to finish their

thesis under three scenarios: best case, expected, and worst case. The averageguesses were 27.4 days, 33.9 days, and 48.6 days, respectively. The actual averageturned out to be 55.5 days.

9) Mutual fund managers, analysts, and business executives at a conference wereasked to write down how much money they would have at retirement and how muchthe average person in the room would have. The average figures were $5 million and$2.6 million, respectively. The professor who asked the question said that, regardlessof the audience, the ratio is always approximately 2:1

10) 86% of my Harvard Business School classmates say they are better looking thantheir classmates

Can lead to straying beyond circle of competence and excessive

leverage, trading & portfolio concentration7


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Economic Overview


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We Have Had Seven Consecutive Quarters of

Economic Growth

Source: TradingEconomics.com; Bureau of Economic Analysis.


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11/60-11-

The Unemployment Rate Is Dropping

Source: Bureau of Labor Statistics, nonfarm payrolls, seasonally adjusted.

3%

4%

5%

6%

7%

8%

9%

10%

11%

UnemploymentRa

te


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The Stock Market Has Responded With

an Enormous Rally

Source: BigCharts.com


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What Worries Us

J b L H B M S Th A


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Job Losses Have Been More Severe Than Any

Downturn Since the Great Depression

And the Recovery Has Been Feeble5.4% of All Jobs Have Disappeared

Source: Bureau of Labor Statistics, nonfarm payrolls, seasonally adjusted.

Job lossfrom peak

-6.5%

-5.5%

-4.5%

-3.5%

-2.5%

-1.5%

-0.5%

0 6 12 18 24 30 36 42 48

Months after pre-recession peak

1948 1953 1958 1960 1969 1974 1980 1981 1990 2001 2007

2007-


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We Believe That We Are in a Period of Unusual Uncertainty

The most likely scenario is neither a boom nor bust but rather

muddling along for 2-7 more years

Jeremy Granthams 10 negatives that are likely to hamper the globaldeveloped economy and lead to seven lean years

1. Over-indebtedness of consumers in certain countries, including the U.S., the U.K., and severalEuropean countries

2. Dangerously excessive financial system debt was moved across, with additions, to becomedangerously excessive government debt

3. We have lost a series of artificial stimuli that came out of the steady increases in debt levels andthe related asset bubbles

4. Very bad things may lie ahead in Europe, and banks in general are undercapitalized and reluctantto lend

5. Runaway costs in the public sector, particularly at the state and city levels, have run into a brickwall of reduced taxes

6. Unemployment is high and will also suffer from the loss of those kickers related to asset bubbles

7. Trade imbalances and the explosion of domestic sovereign debt levels

8. Incompetent management in Spain, Greece, Portugal, Ireland, and Italy allowed the localcompetitiveness of their manufactured goods to become 20% or more uncompetitive with those ofGermany

9. The general rising levels of sovereign debt and the particular problems facing the euro bloc andJapan are leading to the systematic loss of confidence in our faith-based currencies

10. Widespread over-commitments to pensions and health benefits

Source: Jeremy Grantham, GMO, July 2010 letter; www.gmo.com/websitecontent/JGLetter_SummerEssays_2Q10.pdf -15-


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Home Prices Have Declined Every Month Since Last

August But Will Likely See a Seasonal Bounce

Source: S&P Case-Shiller 20-city index, non-seasonally adjusted, through 2/11.

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

Sequential Home Prices February 2000-February 2011

Red circles represent April -June each year


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27.5% of the 54.6 Million Mortgages Are Either

Under Water, Reperforming or Nonperforming

* CoreLogic reports on approximately 60% of the non-PLS universe, which is extrapolated to the entire mortgage marketSource: CoreLogic, Amherst Securities

DQ Status

Number of

Loans

% of

Loans Total Balance

% by

Balance 3Mo cTr 3Mo vPr

3Mo

D/TV

Total

Number of

Loans

Estimated

Default Rate

Number of Homes in

Jeopardy

Total NPL 4,789,189 8.8% 1,007,899,493,730 10.6% - - - 4,789,189 95% 4,549,730

Total RPL 3,540,956 6.5% 602,221,865,995 6.3% 50.6% 2.7% 94.9% 3,540,956 70% 2,478,669

Total APL >120 MTM LTV 2,300,163 4.2% 472,414,609,023 4.9% 16.0% 7.0% 69.5% 2,300,163 50% 1,150,081

Total APL 100-120 MTM LTV 4,398,205 8.1% 874,448,632,538 9.2% 8.8% 10.9% 44.8% 4,398,205 25% 1,099,551

Total APL 120 MTM LTV 1,935,378 3.9% 370,361,634,049 4.5% 14.2% 8.5% 62.6%

NonPLS APL 100-120 MTM LTV 4,090,320 8.2% 773,562,344,109 9.3% 8.0% 11.7% 40.6%

NonPLS APL 120 MTM LTV 364,785 7.7% 102,052,974,974 8.3% 22.4% 1.7% 93.1%

PLS APL 100-120 MTM LTV 307,885 6.5% 100,886,288,429 8.2% 15.3% 4.6% 76.9%

PLS APL


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11.2 Million Homes, Representing 20.5% of

All Homes With Mortgages, Are in Jeopardy

Source: CoreLogic, Amherst Securities

APL 120MTM LTV

4%

RPL7%

NPL

9%

Estimated # of Homes

Category # of Loans Default Rate In Jeopardy

NPL 4.8 95% 4.6

RPL 3.5 70% 2.5

APL >120 MTM LTV 2.3 50% 1.2

APL 100-120 MTM LTV 4.4 25% 1.1

APL


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Our View of the Market


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We Think Were Likely in A Range-Bound Market And

With Interest Rates Low and P/E Multiples High, Its Hard to

See How a Sustained Bull Market Could Occur

Source: Ned Davis Research; WSJ Market Data Group; appeared in WSJ 6/16/09; GNP andinterest rate data: Warren Buffett on the Stock Market, Fortune, 12/10/01

Gain in

GNP

373%

Gain in

GNP

177%

Interest Rates on Long-Term Govt. Bonds12/31/64: 4.20% 12/31/81: 13.65% 12/31/98: 5.09%

Range-bound markets

See: Active Value Investing: Making Money in Range-Bound Markets by Vitaliy Katsenelson

16 years 13 years 17 years 10+ years

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B d I fl ti Adj t d 10 Y T ili


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0

2

4

6

8

10

12

14

16

18

20

0

5

10

15

20

25

30

35

40

45

50

1860 1880 1900 1920 1940 1960 1980 2000 2020

Long-Term

InterestRates

P

rice-EarningsRatio

Year

19011966

2000

Cyclically AdjustedP/E Ratio

Long-TermInterest Rates 19811921

1929

Based on Inflation-Adjusted 10-Year TrailingEarnings, the S&P 500 at 24x Is Trading at a44% Premium to Its 130-Year Average of 16.3x

Source: Stock Market Data Used in "Irrational Exuberance" Princeton University Press, 2000, 2005, updated, Robert J. Shiller.

CurrentP/E: 23.4x

Long-term P/Eaverage: 16.3x

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A i i O i i


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Where We Are Finding OpportunitiesA Year Ago, We Were Playing Offense; Now Were Playing

Defense, As We Trim Both Our Long and Short Exposure and

Shift Our Longs Toward Large, Dominant, Cash-Rich Companies

Blue-chips. The stocks of some of the greatest businesses, with strong balance sheets and dominantcompetitive positions, are trading at reasonable multiples relative to the market, among the cheapestweve ever seen them (on an absolute basis, they were much cheaper in late 2008 and early 2009). Inthis category, wed put Berkshire Hathaway and AB InBev (which we own), Coca-Cola and McDonalds.

Out of favor blue-chips. For somewhat more adventurous investors looking to buy high-qualitybusinesses trading at a discount because of company or industry issues, there are many opportunities.We own Microsoft, BP, Kraft, JC Penney, and ADP.

Balance sheet plays. For investors who are comfortable with lower-quality businesses but want downside

protection, there are still some companies trading near or even below net cash on the balance sheet.Examples in our portfolio include digital media equipment company EchoStar Corp. and clothing retailerdELiA*s.

Turnarounds. There are countless companies that were clobbered by the economic downturn and arenow trying to restore former levels of profitability. We own CIT Group, General Growth Properties, Winn-Dixie supermarkets, and Resource America, a specialty finance company.

Special situations. This is somewhat of a catch-all category that, for us, includes Grupo Prisa, FairfaxFinancial, Howard Hughes Corp. and Contango Oil & Gas.

Mispriced options. Every once in a while we take a tiny position in a highly speculative situation oftenwhere the stock price is below $1 in which theres a real chance that the outcome is zero, but also adecent chance, in our opinion, of making many multiples of our money. On an expected value basis,therefore, a small portfolio of such investments is attractive. In the past, our holdings have included anumber of stocks and warrants of Special Purpose Acquisition Companies (SPACs), General GrowthProperties, TravelCenters of America, Ambassadors International, Borders Group and PhotoChannelNetworks.


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Idea #1: Berkshire Hathaway

This presentation is posted at:

www.tilsonfunds.com/BRK.pdf

B k hi H th A Hi h Q lit


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Berkshire Hathaway: A High-Quality,

Growing 75-Cent Dollar

History

Berkshire Hathaway today does not resemble the company thatBuffett bought into during the 1960s

Berkshire was a leading New England-based textile company, with

investment appeal as a classic Ben Graham-style net-net Buffett took control of Berkshire on May 10, 1965

At that time, Berkshire had a market value of about $18 million andshareholder's equity of about $22 million


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The Berkshire Hathaway Empire Today

Stakes in Public CompaniesWorth $1+ Billion

Note: Shares as of 12/31/10; Stock prices as of 4/19/11.

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Company Shares Price Value ($B)

Coca-Cola 200.0 $67.09 $13.4

Wells Fargo 358.9 $30.07 $10.8

American Express 151.6 $46.64 $7.1

Procte r & Gamble 72.4 $63.86 $4.6

Kraft 97.2 $33.40 $3.2

Munich RE 19.3 $165.52 $3.2

Johnson & Johnson 45.0 $62.69 $2.8

ConocoPh illip s 29.1 $78.15 $2.3

Wal-Mart 39.0 $53.35 $2.1

U.S. Bancorp 78.1 $25.25 $2.0

Sanofi-A ventis 25.8 $71.59 $1.9

POSCO 3.9 $44,344 $1.8

Tesco 242.2 $6.54 $1.6

Moody's 28.9 $35.41 $1.0
https://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&http://www.jordans.com/default.asphttps://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&http://www.jordans.com/default.asphttps://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&https://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&https://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&https://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&http://www.buffalonews.com/default.asphttps://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&http://www.buffalonews.com/default.asphttp://www.bnsf.com/http://www.brick.com/http://www.jordans.com/default.asphttp://www.buffalonews.com/default.asphttp://shop.borsheims.com/Borsheims/Default.aspxhttp://www.shawfloors.com/index.asphttp://www.johnsmanville.com/default.htmhttp://www.sees.com/home.cfmhttp://www.sees.com/home.cfmhttp://www.sees.com/home.cfmhttp://www.netjets.com/default.asphttps://sales.geico.com/quote.do?GENINFO_currentPageName=entry&POL_ratedZip5=&http://www.genre.com/page/0,1019,,00.html


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The Basics

Stock price (4/26/11): $124,450

$82.92 for B shares (equivalent to $124,380/A share)

Shares outstanding: 1.636 million

Market cap: $204 billion

Total assets (Q4 10): $372 billion

Total equity (Q4 10): $163 billion

Book value per share (Q4 10): $95,453


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-27-

Recent Performance of Key Business UnitsEarnings Before Taxes, By Year:

Note: in 2010, Berkshire changed this table from Earnings before income taxes, noncontrolling interests and equity method earnings to Earnings before income taxes. Thus, 2008-2010 reflect the new numbers, and all prior years reflect the old ones.* Burlington Northerns run rate annual operating profits are approximately $4.1 billion ** Shaw Industries was combined with Other Businesses starting in Q1 10

**

***

***

2004 2005 2006 2007 2008 2009 2010

Insurance Group:GEICO 970 1,221 1,314 1,113 916 649 1,117

General Re 3 -334 523 555 342 477 452

Berkshire Reinsurance Group 417 -1,069 1,658 1,427 1,222 250 176

Berkshire H. Primary Group 161 235 340 279 210 84 268

Investment Income 2,824 3,480 4,316 4,758 4,896 5,459 5,145

Total Insurance Oper. Inc. 4,375 3,533 8,151 8,132 7,586 6,919 7,158

Non-Insurance Businesses:

Burlington Northern Santa Fe 3,611

Finance and Financial products 584 822 1,157 1,006 771 653 689

Marmon 733 686 813

McLane Company 228 217 229 232 276 344 369

MidAmerican/Utilities/Energy 237 523 1,476 1,774 2,963 1,528 1,539

Shaw Industries 466 485 594 436 205 144

Other Businesses 1,787 1,921 2,703 3,279 2,809 884 3,092

Total Non-Insur. Oper. Inc. 3,302 3,968 6,159 6,727 7,757 4,239 10,113

Total Operating Income 7,677 7,501 14,310 14,859 15,343 11,158 17,271

*

**


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Recent Performance of Key Business UnitsEarnings Before Taxes and Minority Interests, By Quarter:

Q1 05 Q2 05 Q3 05 Q4 05 Q1 06 Q2 06 Q3 06 Q4 06 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10

Insurance Group:

GEICO 312 358 237 314 311 288 407 308 295 325 335 158 186 298 246 186 148 111 200 190 299 329 289 200

General Re 19 43 -389 -7 71 106 177 169 30 230 157 138 42 102 54 144 -16 276 186 31 -39 222 201 68

Berks hire Rein su ran ce Gro up 143 140 -1,635 283 94 137 735 692 553 356 183 335 29 79 -166 1,280 177 -318 141 250 52 117 -237 244

Berkshire H. Primary Group 18 37 -10 190 35 43 108 154 49 63 77 90 25 81 -8 112 4 29 7 44 33 48 52 135

Inves tment Income 787 851 900 942 1,018 1,102 1,103 1,093 1,078 1,236 1,217 1,227 1,089 1,204 1,074 1,529 1,354 1,482 1,412 1,211 1,283 1,494 1,218 1,150

Total Insurance Oper. Inc. 1,279 1,429 -897 1,722 1,529 1,676 2,530 2,416 2,005 2,210 1,969 1,948 1,371 1,764 1,200 3,251 1,667 1,580 1,946 1,726 1,628 2,210 1,523 1,797

Non-Insurance Businesses:

Burlington Northern Santa Fe 476 974 1,127 1,034

Finance a nd Financia l p roduct s 199 199 207 217 251 343 282 281 242 277 273 214 241 254 163 113 112 115 119 307 111 155 140 283

Marmon 28 261 247 197 162 170 194 160 190 219 212 192

McLane Company 69 59 53 36 55 56 50 68 58 72 50 52 73 68 68 67 143 66 64 71 80 109 89 91

M idAmeric an /Ut ilit ie s/ Energy 141 100 141 141 418 278 416 364 513 372 481 408 516 329 526 1,592 303 402 441 382 395 338 416 390

Shaw Industries* 88 139 145 113 155 169 138 132 91 111 125 109 51 82 49 23 55 30 51 8

Other Businesses* 364 514 486 557 430 671 686 916 632 904 895 848 693 874 749 493 151 171 299 263 583 860 844 805

Total Non-Insur. Oper. Inc. 861 1,011 1,032 1,064 1,309 1,517 1,572 1,761 1,536 1,736 1,824 1,631 1,602 1,868 1,802 2,485 926 954 1,168 1,191 1,835 2,655 2,828 2,795

Total Operating Income 2,140 2,440 135 2,786 2,838 3,193 4,102 4,177 3,541 3,946 3,793 3,579 2,973 3,632 3,002 5,736 2,593 2,534 3,114 2,917 3,463 4,865 4,351 4,592

Note: in 2010, Berkshire changed this table from Earnings before income taxes, noncontrolling interests and equity method earnings to Earnings before income taxes, but a

breakdown of Q1-Q3 numbers in 2008-2010 isnt available, so we use the old numbers for Q1-Q3 of each year, but to get the Q4 numbers in 2008-2010, we subtract from the full-yearnumbers, which causes slight anomalies in Q4 08, Q4 09 and Q4 10.* Shaw Industries was combined with Other Businesses starting in Q1 10


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Berkshire Is Becoming Less of an Investment

Company and More of an Operating Business

Source: 2010 annual letter.

*

Th B li t N th A i iti


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(10)

(5)

0

5

10

15

20

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Acquisitions Net Stock Purchases

-30-

The Burlington Northern Acquisition

Dwarfs Anything Before It

Hes doing a good job but the cash is coming in so fast! A high-class problem

Markets have a way of presenting big opportunities on short notice Chaos in 2008, junk bonds in 2002

Buffett has reduced average maturity of bond portfolio so he can act quickly

$B

Cash paid, mostly forBurlington Northern

(the total value of the company atacquisition was $34 billion)

Buffett Invested Large Amounts of


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-31-

Buffett Invested Large Amounts of

Capital During the Downturn in 2008

Investment/Commitment Amount (Bn) Comment

Mars/Wrigley $6.5

Auction rate securities $6.5 Q2 event; sold much in Q3

Goldman Sachs $5.0 Plus $5B to exercise warrants

Constellation Energy stockand preferred

$5.7 Sold for a $1.1B gain incl.breakup fee

Marmon $4.5 The remaining 34.6% notowned by BRK will bepurchased from 2011-14

General stock purchases $3.3 Full year; net of sales

Dow/Rohm & Haas $3.0

General Electric $3.0 Plus $3B to exercise warrants

Fed. Home Loan Disc. Notes $2.4 Q2 event; sold much in Q3

Tungaloy $1.0 Iscar acquisition

Swiss Re unit $0.8 Plus sharing agreement

ING reinsurance unit $0.4

Other businesses purchased $3.9

TOTAL $46.0 Plus $8B to exercise GS &GE warrants

Note: Does not include capital committed to Berkshires new bond insurance business, Berkshire Assurance


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Valuing Berkshire

Over the years we'veattempt[ed] to increase our marketable investments inwonderful businesses, while simultaneously trying to buy similar businesses in theirentirety. 1995 Annual Letter

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

In effect, the columns show what Berkshire would look like were it split into two parts,with one entity holding our investments and the other operating all of our businesses and

bearing all corporate costs. 1997 Annual Letter

B ff tt C t B k hi V l ti L d


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Buffetts Comments on Berkshires Valuation Lead

to an Implied Multiplier of Approximately 12

1996 Annual Letter: Today's price/value relationship is both much different from whatit was a year ago and, as Charlie and I see it, more appropriate.

1997 Annual Letter: Berkshire's intrinsic value grew at nearly the same pace as book

value (book +34.1%) 1998 Annual Letter: Though Berkshire's intrinsic value grew very substantially in1998, the gain fell well short of the 48.3% recorded for book value. (Assume a 15-20% increase in intrinsic value.)

1999 Annual Letter: A repurchase of, say, 2% of a company's shares at a 25%discount from per-share intrinsic value...We will not repurchase shares unless webelieve Berkshire stock is selling well below intrinsic value, conservativelycalculated...Recently, when the A shares fell below $45,000, we considered making

repurchases.

Pre-tax EPSExcluding All Year-End

Investments Income From Stock Intrinsic Implied

Year Per Share Investments Price Value Multiplier

1996 $28,500 $421 $34,100 $34,100 13

1997 $38,043 $718 $46,000 $46,000 11

1998 $47,647 $474 $70,000 $54,000 131999 $47,339 -$458 $56,100 $60,000


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Pre-tax EPS

Excluding All SubsequentInvestments Income From Intrinsic Value Year Stock

Year End Per Share Investments Per Share Price Range

2001 $47,460 -$1,289 $64,000 $59,600-$78,500

2002 $52,507 $1,479 $70,000 $60,600-$84,700

2003 $62,273 $2,912 $97,000 $81,000-$95,700

2004 $66,967 $3,003 $103,000 $78,800-$92,0002005 $74,129 $3,600 $117,300 $85,700-$114,200

2006 $80,636 $5,200-$5,400 $143,000-$144,400 $107,200-$151,650

2007 $90,343 $5,500-$5,700 $156,300-$158,700 $84,000-$147,000

2008 $75,912 $5,727 $121,728 (8 multiple) $70,050-$108,100

2009 $91,091 $3,571 $126,801 (10 multiple) $97,205-$128,7302010 $94,730 $7,200 $166,730 (10 multiple) ?

Estimating Berkshires Value: 2001 2010

1. Unlike Buffett, we include earnings from Berkshires insurance businesses.2. Actual result was $6,492, but we reduce this to assume the 2nd-worst year ever for super-cat losses.3. Actual result was $6,270 but we reduce the pre-tax, pre-investment-income margins of the insurance businesses by 400 basis points

(from 14% to 10%) to reflect Buffetts guidance in the Annual Report.

Given compressed multiples at the end of 2008, we used an 8 rather than a 12 multiple.Weve now increased this to a 10 multiple, still below the historical 12 multiple we believe Buffett uses.

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1

2

3

Even Using an 10 Multiple Berkshire Is


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Even Using an 10 Multiple, Berkshire Is

25% Below Intrinsic Value

Intrinsic value*

* Investments per share plus 12x pre-tax earnings per share (excluding all income from investments) for theprior year, except for YE 2008 (8 multiple) and YE 2009-10 (10 multiple).

Intrinsic value estimate of

$167,000 using 10 multiple

25% discount tointrinsic value

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12-Month Investment Return

Current intrinsic value: $167,000/share

Plus 5% growth of intrinsic value of the business

Plus cash build over next 12 months: $7,000/share

Equals intrinsic value in one year of $182,000

46% above todays price

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Catalysts

Continued earnings growth of operating businesses

The impact of Burlington Northerns impact on earningsbecomes clear

$1+ billion of pre-tax earnings from Lubrizol

New equity investments Additional cash build

Eventually, Berkshire could win back a AAA rating (not likely inthe near term)

Potential for more meaningful acquisitions and investments

If theres a double-dip recession, this becomes more likely


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Risks

Sokol-gate takes a turn for the worse A double-dip recession impacts Berkshires earnings materially

No catalyst occurs, so the stock sits there and doesnt go up

Intrinsic value will likely continue to grow nicely

Something happens to Buffett He turned 80 last Aug. 30th and is in excellent health

Little Buffett premium in stock today

Berkshires stock portfolio declines

Losses in the shorter-duration derivatives such as credit-default

swaps are larger than expected and/or mark-to-market lossesmount among the equity index puts

A major super-cat event occurs that costs Berkshire many billions

Berkshire is downgraded


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Conclusion

Cheap stock: 75-cent dollar, giving no value to recentinvestments and immense optionality

Extremely safe: huge cash and other assets provide downsideprotection

Strong earnings report should act as a near-term catalyst


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Idea #2: Microsoft


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Microsoft: Myths vs. Facts

Myth: Microsofts a dying company (think newspaper, paging companies and checkprinters), with declining sales, margins and market share

Facts: Dominant market shares in key product categories are stable or rising,revenues are rising at double-digit rates, margins are rising, and profits aresoaring (24% EPS growth last quarter (Q3), excluding one-time tax gain).

Myth: Microsoft isnt innovative

Facts: Windows 7 and Office 2010 are hit products and very popular; in Q3 11,Microsoft sold 2.7 million Xboxes and 2.4 million Kinects; in cloud computing,Microsoft recently signed a five-year, $100 million cloud computing deal with theNY state government (120 departments and 100,000 personal computers), plusa similar agreement with the California state government, covering 200,000employees. It signed a deal with the Minnesota state government covering33,000 employees and another with DuPont.

Myth: Microsoft has engaged in bad capitol allocation

Fact: Microsoft has eschewed big (usually stupid) acquisitions and has insteadreturned massive amounts of cash to shareholders. In last three quarters,Microsoft has paid out $3.8 billion in dividends (2.4% yield) and repurchased$10.3 billion in stock, which reduced the share count in Q3 by 4.1% year overyear.

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Microsoft Stock Price

Microsoft Over the Past Three Years

Microsoft Over the Past Ten Years


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Key Financials

12 months

Jun-30-2007

12 months

Jun-30-2008

12 months

Jun-30-2009

12 months

Jun-30-2010

LTM12 months

Dec-31-2010

Total Revenue $51,122 $60,420 $58,437 $62,484 $66,690

Growth Over Prior Year 15.4% 18.2% -3.3% 6.9% 13.6%

Gross Profit 40,429 48,822 46,282 50,089 52,793

Margin % 79.1% 80.8% 79.2% 80.2% 79.2%

EBITDA 20,385 26,002 23,267 27,197 29,579

Margin % 39.9% 43.0% 39.8% 43.5% 44.4%

Operating Income (EBIT) 18,949 24,130 20,976 24,690 26,976

Margin % 37.1% 39.9% 35.9% 39.5% 40.4%

Net Income 14,065 17,681 14,569 18,760 20,568

Margin % 27.5% 29.3% 24.9% 30.0% 30.8%

Diluted EPS Excl. Extra Items 1.42 1.87 1.62 2.10 2.34

Growth Over Prior Year 18.9% 31.2% -13.3% 29.6% 28.8%

Shares Outstanding (Diluted) 9,886 9,470 8,996 8,996 8,204

Total Net Cash, Equity & Investments 31,172 27,759 28,972 38,374 40,327

In millions, except per share items


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Highlights

Very Cheap Stock

Stock Price: $25.92 (close on 4/29/11)

Net Cash, Equity and Other Investments Per Share: $5.76

TTM Earnings: $2.50

Historically Cheap Multiple: 8.1x trailing, 7.6x 2011 estimated earnings of$2.66, net of cash

Currently on the front-end of a Large New Product Cycle

MS Office 2010

MS Windows 7

Microsoft is A Key Player in Emerging Themes

Cloud Computing/Virtualization

Mobile

Search

Shareholder Friendly Capital Allocation

In last three quarters, Microsoft has paid out $3.8 billion in dividends (2.4%

yield) and repurchased $10.3 billion in stock, which reduced the sharecount by 4.1% over the past year


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S t Fi i l B kd


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Segment Financial Breakdown

$4,415

$3,575$566

$4,243

$1,665$39

Windows & Windows Live Division Server and Tools Online Services Division

Microsoft Business Division Entertainment and Devices Division Corporate-level activity

$3,061

$1,255

-$713

$2,622

$165

-$1,217

Segment Revenue($ millions; qtr ended 3/31/10)

Segment Oper. Profit($ millions; qtr ended 3/31/10)

Rumors of Microsofts Demise


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Rumors of Microsoft s Demise

Are Greatly Exaggerated



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Are Greatly Exaggerated (2)

PC Shipment Share By Operating System

Source: Gartner



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Are Greatly Exaggerated (3)

Office Suites Market Share (2009)

Source: Gartner


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Expected Return/Potential Upside

Analysts are currently expecting Microsoft to earn approximately $2.66in calendar year 2011, up 14% YOY. We think this is too low,especially given the rate of share repurchases.

We wouldnt be surprised to see Microsoft earn $2.75 in calendar year2011, up 18% YOY.

MSFTs closing price on 4/29/11: $25.92, so assuming $2.75/share of2011 earnings, plus $6/share in cash, here are possible stock pricesand returns (plus theres a 2.4% dividend):

Multiple 10x 12x 15xStock price $33.50 $39 $47

Return 29% 50% 82%


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Though We Have Gotten Burned Here


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Though We Have Gotten Burned Here,

We Are Finding a Few Opportunities

on the Short Side Among MomentumStocks Priced for Perfection

Wh t C I Thi ?


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What Company Is This?

It had Q4 net income of $11 million ($0.08/share, down 50% YOY) and 2010 net income of $64 million ($0.47, down25%), and gave guidance for next quarter of a small loss ($0.01-$0.02) and for next 12 months of $0.08-$0.11, downanother 75%+ from the last 12 months. Even using the companys pro-forma earnings (which exclude massivestock-based expense), last years earnings were $1.22, up 6% YOY, and the forecast of the next 12 months is$1.35-$1.38, up 11-13%.

On the plus side, the companys customers love the product and it is growing rapidly: revenues were up 29% and27% in the last quarter and year, respectively, with TTM revenues of $1.7 billion. Also, operating cash flow was $166million last quarter and $459 million last year, vs. only $31 million and $91 million, respectively, in cap ex. Thus, freecash flow last quarter was $135 million, equal to 30% of revenues ($457M in Q4), so at least on this metric, it appears

to have high margins. Finally, the company has $1.4 billion in cash, short-term marketable securities, and noncurrent(long-term) marketable securities (equal to $10/share), with no debt.

So how much might this rapidly growing, high-margin (maybe) company be worth? Before you answer that, youmight want to know that the gorilla of the industry, with more than 40x this companys sales, is making a big push witha directly competitive product which is now available in 40 markets and 41 languages at to 1/3 of the price.

Also, the company gives out stock options by the bushel, such that the share count rose 7.3% YOY last quarter, andthe CEO, through 12/31/10, had an automatic selling program in place and was selling stock every day the marketwas open valued at more than $1.3 million (more the double the companys total profits per day). Overall, the

company has the second-highest insider selling ofanycompany in the U.S. market. So whats it worth? Call me old school, but I think GAAP earnings matter and I think allcompensation is an expense,whether its in the form of cash or stock options. But the company basically has no GAAP earnings to speak of, nor isit expecting any this year, so lets give the company every benefit of the doubt and use its pro-forma earnings: $1.22trailing and $1.38 (the high end) for this year (up a mere 13%). What would be an appropriate multiple? 20x? 30x?Using 30x x $1.38 = $41.40 plus $10 in cash = $51.40. As I write this, the stock is nearly 3x this at $138.83, giving ita market cap of $19.5 billion.

Lets be even more generous and use free cash flow, and lets annualize $135M of FCF in Q4, so thats $540 million.Put a 20 multiple on this and thats $10.8 billion, plus cash equals $12.2 billion, just over half of the current value.

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A S l f


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Answer: Salesforce.com

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