IN THE MIDST OF THE MARKET MAYHEM last August, Third Avenue Management sent a two-page letter to shareholders in its four mutual funds, including its flagship $10 billion Third Avenue Value Fund. The message: It’s time to buy.
Far from taking shelter, the firm’s chief executive, David Barse told investors that the emerging bear market was irrelevant, except that it was making attractive stocks cheaper by the day. “As long as we continue to have available funds to invest, we intend to continue to take advantage of the unprecedented opportunities presented to us during this bear-market ‘panic’,” the letter said.
When Marty Whitman reviewed the shareholders’ letter at home, he was impressed — and acted. “I was about to put some money into muni bonds for my wife, and instead put it into Third Avenue Value,” he says. Perhaps that’s not surprising, given that the marketing pitch reflected the investment philosophy and outlook of the 83-year-old Whitman, Third
Avenue’s1 founder and manager of the fund (ticker: TAVFX).
Leave it to other value investors to step back from the ongoing market turmoil; Whitman thrives on snapping up securities that others shun. “We worry infinitely more about value than market outlook — and since the near-term outlook stinks, no matter where you go, that is helping to create a lot more value for us to take advantage of,” he observes.
THE VETERAN MONEY MANAGER NEVER HAS SHIED away from a bear market, and he’s not going to start now. Along with Barse, he’s slashed the fund’s cash holdings from 20% of its assets as of last summer to 10% today, and reopened two of three funds that had been closed to new investors. (The firm is pondering reopening the remaining one, Third Avenue Small-Cap Value2 (TASCX).)
Whitman even mulled investing in Bear Stearns as the investment bank’s turmoil worsened. “Why not?” he says now, shrugging. “If it was creditworthy, it was going to $100.” He acknowledges, however, that his designated successor as manager of Third Avenue Value, Ian Lapey, “saved my ass on that one. He and I have to agree on any transaction in the fund, and he said ‘No way!’ on Bear Stearns because he couldn’t make sense of what was on their books.”
The ability to understand the nuts and bolts of a company’s business and its books is one of the three criteria Whitman trains his team to examine before plunging into any potential deep-value investment. “He has taught us all that three things signal safety: a strong balance sheet; good management; and an understandable business,” says Barse. “Together, these help you limit and manage the investment risk.”
Just because Whitman, Barse and Lapey ultimately passed on Bear Stearns doesn’t mean they are spurning other victims of the credit crunch.
One of their biggest new holdings is beleaguered bond-insurer MBIA (MBI), whose stock has plunged from its 52-week high of $72.38 last April to a low of $6.75 in January, before struggling back to around $14, where it’s been hovering for many weeks. The firm has been one of the prime targets of short-sellers, who argue that MBIA ultimately could face huge liabilities because its underwriters guaranteed mortgage-backed securities that include now-toxic subprime loans, defaults on which helped trigger the global credit crisis.
Whitman pooh-poohs that analysis. When MBIA went out in search of new capital, Third Avenue ponied up a chunk of cash, to the tune of some 15% of the total $2.6 billion infusion into MBIA in February, at a price of about $12.15 a share. He figures the stock is worth closer to $35 — at least. “Just because some of the securities are flawed doesn’t mean the backer is in trouble,” he maintains. “There are a whole bunch of amateurs out there running around and creating noise.”
Whitman is anything but an amateur.
Value Investing: A Balanced Approach, his recently reissued book on value investing, is viewed as a classic. Although Third Avenue Value didn’t open its doors until 1990 — when Whitman was already 65, a senior citizen by Wall Street standards — the value-investing maven learned his trade in a series of jobs as a Street analyst before launching his own firm in 1974.
WHITMAN’S ABILITY TO FERRET OUT BARGAIN-PRICED securities in even the trickiest of markets wins plaudits from Morningstar analysts. “Marty is precisely the kind of manager you want to be investing with in this kind of environment,” says Karen Dolan, director of fund analysis at the Chicago-based research firm. “He has a high pain threshold, as long as he sees the value and the potential in a company.”
Not every troubled-company workout generates for Third Avenue investors the kind of outsized profits that came from Whitman’s decision to invest in bonds issued by a then-bankrupt Kmart. After Kmart’s resurrection, culminating in its merger with Sears Holdings (SHLD), Third Avenue Value captured a “ten-bagger,” or tenfold, return, says Whitman.
Notes Dolan “Marty has an ability to identify more of those that do survive tough times; that knack has meant that the fund has only had two down years.” Those came in 1994 and 2002 — and Dolan adds that, even in the latter year, a particularly trying one for the stock market, Third Avenue Value fared better than half of its peers. And the following year, Whitman delivered a 37% return.
True, the prospects for a profitable 2008 don’t look great right now, even as Whitman, Barse and their team have taken the fund’s cash levels from 20% back down to 10% in their pursuit of bargains such as MBIA and other bond-insurance outfits.
This year, through Wednesday, the Standard & Poor’s 500 stock index was down 6.4%, and the Russell 2500 was off 6%. Third Avenue Value was down 8.4%%. That kind of short-term showing doesn’t rattle Whitman and his team, who have one of the longest investment horizons on Wall Street: As long as his analysis pans out or the value analysis remains compelling, Whitman doesn’t mind keeping his chips on the table for years, even decades.
Third Avenue Value’s biggest holdings currently include stakes in St. Joe (JOE) and Forest City Enterprises (FCE.A), both of which were initiated back in July 1991. Whitman admits that St. Joe, once a forest-products company, has failed to live up to what he sees as its potential as a land company. “It’s been very disappointing,” he admits, but adds that he isn’t prepared to walk away.
The same is true of long-time holding Toyota Industries (6201.Japan), which owns stakes in a number of operating businesses. Whitman’s analysis showed that the stock had been trading at a 40%-to-50% discount to the value of its share of the earnings of those underlying businesses, in addition to a conservative multiple of its own operations. While the stock has appreciated more than 50% in yen over the 9½ years he has held it, the discount remains.
“It’s a frustration,” he says. “It’s a great business performer, but an unsatisfactory stock-market performer.” [whitman]
Whitman — who worries “infinitely more about value than market outlook” — has found lots to buy in the volatile investment environment of the past year.
OTHER KINDS OF ECONOMIC HEADWINDS DON’T trouble Whitman and Barse in the least. Currently, some investors might recoil from real-estate stocks such as Brookfield Asset Management or Forest City. Yet real-estate names dominate Third Avenue Value’s list of holdings. Each offers the combination of an understandable business, strong finances and talented management.
“Bruce Flatt [CEO of Brookfield] is Canada’s Warren Buffett,” Whitman proclaims.
And sure, the credit crunch may have forced Forest City to postpone plans to build a massive residential and commercial real estate project around a basketball stadium in New York’s borough of Brooklyn; in addition, its stock trades around 38 a share, down from a 52-week high of 73.84, reached last June. But Whitman, who paid a mere $2.37 a share for his stake in Forest City, focuses on what, to him, is more crucial: the company’s strong financial position. “They can afford to be patient as some competitors struggle to survive,” he notes. Indeed, he points out, Forest City has snapped up building lots from troubled rivals at deep discounts.
Many of the more recent additions to the Third Avenue Value portfolio are of overseas stocks or domestic bonds rather than stocks. “We’re not going to add [U.S.] common stocks unless the company has a strong balance sheet,” Whitman says. “We’d prefer to own debt.” That, he says, is increasingly possible: the credit market deep-freeze has created many value opportunities in securities like GMAC senior unsecured notes and surplus notes issued by MBIA.
The Bottom Line:
Bond-Insurer MBIA is one of Whitman’s favorite stocks. He considers its critics ill-informed “amateurs.” Recently, trading around 14, MBIA ultimately could hit 35, he says.
The comfort factors? The MBIA notes rank senior to other company securities, while GMAC notes are supported by a great pipeline of receivables, Barse points out. “If I pick the right security, I don’t have to worry about today’s market value,” Whitman adds. “I just have to hold it to maturity and collect the income — and there is a lot of stuff out there that I can now buy with yields to maturity of 15%.”
Still, today’s market environment means that pursuing opportunity may require embracing volatility. Third Avenue Value’s current portfolio is dominated by a group of Hong Kong-based real-estate companies, from Henderson Land (12.Hong Kong) and Hang Lung Group (10.Hong Kong) to Cheung Kong Holdings (1.Hong Kong). Says Whitman: “We went in there two years ago, and were able to buy these companies — all of which have a big pipeline of property developments in China — at big discounts.”
CHINESE STOCKS HAVE PLUNGED THIS YEAR, but Whitman isn’t perturbed.
“Income-producing real estate is one of the businesses that is easiest to understand and value, and these are great long-term investments,” he insists.
“Sure, you have political risk, Tibet, pollution, crazy Communists and all kinds of other risks,” Whitman adds, but deciding whether to invest in China is all about the balance of probabilities. “Lots of things could go wrong — but part of seizing value is being willing to look past the noise, no matter how loud it is.”
“CASH AND KNOWLEDGE” are the keys to riding out a recession, says Bruce Berkowitz of the Fairholme Fund (FAIRX). Fairholme has lost just 1.10% this year, easily topping most funds’ performance. Even so, “I’m not happy with it,” says Berkowitz. “You can’t spend relative performance” when it’s time to pay dividends. A fund, he adds, “can bleed to death” in the current environment.
Berkowitz, whom Barron’s interviewed last month (“Betting Big, Winning Big,”
March 17), says it’s a particularly tricky environment because it’s impossible to understand some of the positions that embattled banks actually hold.
As a result, he recently had about 20% of his $7.4 billion fund’s assets in cash. His top equity holding: Berkshire Hathaway (BRK-B), run by Warren Buffett. He’s a great guy to have on your team as a tough season gets under way.