Akre November 2006

Having first invested in BerkshireHathaway in the mid-1970s,Chuck Akre has a simple explana-tion for the shares' rise from $100 to over$105,000. They grew book value at anabove-average rate for most of that timeabove 20% per year, he says. Thatbecame the holy grail for me.

Following this holy grail to identifypotential investments has paid off hand-somely for Akre, who now manages $1.7billion. His flagship partnership has returnedan annual 21.3% (net) since 1993, vs.10.7% for the S&P 500.

Akre casts a wide net in his search forcompounding machines, identifying cur-rent opportunities in such varied industriesas insurance, gaming, automotive supplyand dollar stores. See page 11

I N V E S TO R I N S I G H T

Chuck AkreAkre Capital Management

Investment Focus: Seeks high-return-on-capital businesses with excellent futurereinvestment opportunities that are not fullyappreciated by the market.

ValueInvestor November 30, 2006Alpha from OmegaLee Cooperman began his storied Wall Street career before many of todayshot fund managers were born and he hasnt lost a step yet.

As a Goldman Sachs partner andCEO of its asset management busi-ness in 1991, Lee Cooperman wasfinancially secure, highly respected on WallStreet and itching to run his own show.It was time, he says. I chose the nameOmega, the end of the Greek alphabet,because this would be my last venture.

The second chapter of Coopermanscareer has been as impressive as the first. HisOmega Advisors, launched at the start of1992, now manages $5 billion and its flag-ship fund has earned net returns of 16.3%per year, vs. 10.6% for the S&P 500.

Coopermans wide-ranging quest forvalue is currently uncovering many oppor-tunities, including those in energy, healthcare, Japan and what he calls quality-growth companies. See page 2

Inside this IssueF E ATU R E S

Investor Insight: Leon CoopermanWhile seeing the overall equity out-look as respectable, finding unrec-ognized value in Corning, 3M,Omnicare and Transocean. PAGE 1

Investor Insight: Charles AkreBetting on the compounding power ofPenn National Gaming, Markel,American Tower, OReilly Automotiveand 99 Cents Only Stores. PAGE 1

A Fresh Look: Tiger vs. BerkshireHis touch appeared to be gone whenhedge-fund titan Julian Robertsonclosed up shop. It wasnt. PAGE 19

Interview: Julian RobertsonReflecting on his evolving concept ofvalue, retirement and what hemakes of todays market. PAGE 21

Editors LetterTrying to understand why everyoneisnt a value investor. PAGE 23

I NVESTM E NT H IG H LIG HTS

Other companies in this issue:AmeriCredit, Bed Bath & Beyond,

Berkshire Hathaway, CarMax, China

Shenhua Energy, Cisco, Citigroup, Consol

Energy, Crown Castle, CSK Auto,

Gazprom, Lukoil, Microsoft, Mirant,

Mohawk Industries, News Corp., Oracle,

Royal Dutch Shell, Ryanair, Time Warner,

UnitedHealth, Wal-Mart

Compounding InterestCEOs who truly focus on compounding shareholders capital per share are arare breed. Chuck Akres success rests on betting big when he finds them.

I N V E S TO R I N S I G H T

Leon CoopermanOmega Advisors

Investment Focus: Seeks companiestrading at significant discounts to their pri-vate-market values, often due to inappropri-ately valued growth prospects.

The Leading Authority on Value Investing INSIGHT

www.valueinvestorinsight.com

INVESTMENT SNAPSHOTS PAGE

3M Company 7

99 Cents Only Stores 17

American Tower 15

Corning 5

Markel 14

Omnicare 8

OReilly Automotive 16

Penn National Gaming 13

Transocean 9

Your investing strategy can be describedas multi-faceted. Explain the variouscomponents.

Lee Cooperman: We basically try to makemoney for our investors in five differentways. First, we take a position on marketdirection: Do we think stocks are under-valued and likely to go up or are theyovervalued and likely to go down? Asgood as you are at picking stocks, if youget the market wrong it can overwhelmindividual selection.

Second, we spend a fair amount oftime on the asset-allocation decision,making a determination on what assetclass has the best prospective investmentreturns 12 months ahead. At the mostbasic level, were looking at stocks vs.bonds vs. cash, but we also go deeper intoeach category, investment-grade vs. high-yield bonds, for example.

Third, our bread-and-butter businessand where weve been quite successful isin finding undervalued individual stockson the long side. Fourth, we look forovervalued stocks on the short side.Finally, we also make macro invest-ments, in currencies, global fixed incomeand the major international indices.

Many value investors Warren Buffettmost prominently say they spend littletime thinking about the markets overalldirection. Why is that an important partof your strategy?

LC: Were not a slave to our market view,but the truth of the matter is that a risingtide does lift all boats and a falling tidelowers them. I would suspect evenWarren Buffett has some fairly clear andstrongly held broader views when hesshort dollars, for example, to the tune of$19 billion. We just apply the same typeof thinking when setting our equity-mar-ket exposure.

Steven Einhorn: Virtually all studies showthat about 60% of the return and volatil-ity of the average common stock is deter-mined by the movement in the aggregatestock market. So while were bottom-upstock pickers, we think its important tohave a view of the economy and the over-all market to help us determine whichindustries and sectors to emphasize.

LC: There are thousands of mutual fundsthat will happily manage your money fora management fee of 1% or less. If yourea hedge fund with the audacity to chargebetween 1% and 2% as a managementfee and take 20% of the profits, yourclients have the right to expect somethingmore. What I consider more is thatwhen the markets overvalued, my clientsexpect me to figure it out and be hedgedand out of harms way. When the mar-kets undervalued, they want me to beleveraged to the upside. If the U.S. isuninteresting, they expect me to findsomething around the world that makessense. Thats why I want to have diversi-fied capability we have an excellentteam that is also looking at fixed income,commodities and currencies. Those areareas, if we do them well, in which wecan produce additive returns without nec-essarily correlated risks.

Do you consider todays U.S. equity mar-ket overvalued or undervalued?

SE: Id describe our view of the U.S. mar-ket outlook as respectable. That means amarket that isnt susceptible to pro-nounced downside risk and that shoulddeliver a high single-digit to low double-digit total return over the next 12 months.

What are the factors driving that view?

SE: One is the economy, which we believewill grow modestly over the next 12-15

I N V E S TO R I N S I G H T : Leon Cooperman

Investor Insight: Leon Cooperman

Value Investor Insight 2November 30, 2006 www.valueinvestorinsight.com

Omega Advisors Leon Cooperman (along with Steven Einhorn, Mark Cooper, Michael Freedman and David Mandelbaum)describes why he always has a view on the overall market, why energy is his largest sector exposure, the worst aspect ofmoney management and why he sees undiscovered value in Corning, 3M, Omnicare and Transocean.

Leon Cooperman

The Forest and the Trees

In 40 years on Wall Street, Lee Coopermanhas distinguished himself both by an abilityto see the big picture as well as to dive intothe details. He rose through the researchside of Goldman Sachs, eventually chairingthe firms investment committee and run-ning its asset management business. Hewas named the #1 portfolio strategist fornine straight years in Institutional InvestorsAll-America Research Team survey. At thesame time, the thoroughness of hisresearch on individual companies is leg-endary to this day, hes well-known forinsightful and tough questioning of execu-tives on analyst calls.

At 63, Cooperman shows no sign of lettingup. As he describes it: I grew up in theSouth Bronx and am a graduate of P.S. 75and Morris High School. I went to CityUniversity of New York for $24 a semester. Ithen spent 16 months at ColumbiaUniversity getting an M.B.A., graduating onJanuary 31, 1967. With a six-month-old son,National Defense Education Act studentloans and no money in the bank, there wasno opportunity to go on the obligatory six-month tour of Europe before going to work. Istarted at Goldman Sachs the day after Igraduated from business school and Ivebeen working that same way ever since.

months at an annual rate of 2% to 2.5%.We think thats a sweet spot for the equi-ty market fast enough to deliverrespectable earnings growth, but slowenough to bring about a moderation inthe rate of inflation and to keep the Fedfrom tightening. Housing is clearly in themidst of a very significant downturn,which will take a percentage point off ofGDP growth, but we think capital invest-ment in energy and growth from foreigndemand will offset that and keep theeconomy growing.

We also think inflation is likely tobecome more tame as the economy slows.The best evidence for that is that inflationexpectations built into fixed-incomeprices have been receding in the past sixmonths and are at a 12-month low.

The third driver of our positive marketview is the strength of corporate profits,which have been terrific. Its amazing thatfive years into an economic expansion,72% of companies are reporting positiveearnings surprises. Next year, thoughgrowth will slow, we think earnings willgrow another 7-9%.

Related to that, the condition of thecorporate sector is terrific. Returns onequity and profit margins are close torecord levels, balance-sheet leverage isdown, dividends are growing 10-12%and share buybacks are near a peak. Withall that, we consider the market to bemoderately undervalued. Absolute P/Esare the lowest theyve been in 15 yearsand relative to interest rates and inflation,the market is attractively priced.

LC: To reverse the question, we look atwhat would change our mind from thisconstructive view. Every bear market,with the exception of the one followingthe Cuban missile crises in 1962, has beenbrought on by a recession. We talk regu-larly to companies like GE and FederalExpress and retailers and the worst youhear is a possible slowdown in growth,not a recession. Our view would also like-ly change with a meaningful accelerationof inflation that brought the Fed backinto play. We dont see that and are oper-ating under the assumption the Fed isdone tightening for at least six months.

The third big negative would be a disrup-tion in the energy supply chain thatcaused oil prices to spike back up to theupper $70s thats very difficult to pre-dict, but we might see the beginning ofdemand destruction if that happened.

When the rate of inflation has beenbetween 1% and 3%, historically the S&P500 multiple on forward earnings hasaveraged over 17x. Inflation is now in thatrange, but the current S&P multiple isaround 15x. In this type of environment,

we think the idea of buying a 10-year gov-ernment bond at a 4.6% yield makes nosense relative to the stock market.

How is that view translating into yourcurrent asset allocation?

LC: Were heavily invested, about 82% netlong. Since we started Omega, our averagenet exposure has been closer to 70%. Wedont short in order to call ourselves ahedge fund, but when we think we canmake money at it. With all the liquidityand buyout activity out there, we haventseen a lot of profitable opportunities onthe short side with equities. We do thinkfixed income is overvalued, so we have ashort position on 10-year Treasuries.

How active are you in foreign equities?

LC: Wed like to have more, but we cur-rently have about 15% of our equityexposure outside the U.S., mostly inWestern Europe and Japan. We do verylittle in emerging markets after ourexperience with Russia abrogating itsdebt in 1998 but have positions inChina Shenhua Energy, the largest coalcompany in China, and Lukoil and

Gazprom, which we think are uniqueRussian energy companies. Lukoil, forexample, has reserves equal to Exxons,but trades at one-sixth the market capital-ization of Exxon.

The gamble in China and Russia is onrule of law. The fundamentals of the com-panies are outstanding the question iswhether these countries are committed toopen economies and capitalistic rewards.

In individual stock selection, what signalsto you that something is undervalued?

LC: Heres how we think about it: TheS&P 500 companies sell at 15x nextyears earnings, 3x book value, 11x cashflow, 1.5x revenues, have an ROE of 17-18% and have anticipated trend earningsgrowth of 8%. Were looking for compa-nies with equal or superior growth char-acteristics that sell at discounts to themarket valuation.

Is it always a relative view?

LC: No, for us to buy something it has tobe absolutely cheap and also cheap rela-tive to the market.

We use the typical absolute approachesto valuation based on discounted cashflow, asset values, earnings power toarrive at what we think a companys truebusiness value is. Publicly traded compa-nies have essentially two values: the auc-tion-market value, which is the price any-one pays for 100 or 100,000 shares, andthe private-market value, which is theprice an informed buyer would pay for100% control. Were looking for compa-nies where the difference between thosetwo values is the highest and, ideally,where we can identify a catalyst forchange. Were also looking for mispricedgrowth, where our view of the growthpotential or the value of that growthpotential differs from the markets.

How do you generate ideas?

LC: We have 12 people working on theidea side. We give them responsibility foran agreed-upon universe of companiesand we expect them to mine those compa-



ON SHORTING EQUITIES:

With all the liquidity and buyout

activity out there, we havent

seen a lot of profitable oppor-

tunities on the short side.

nies for the opportunities Mr. Marketpresents. They go about mining thoseopportunities in different ways, but noth-ing goes into the portfolio without some-ones initials by it and my approval.

When you hire people, you have to givethem enough rope to prove what they cando and be willing to share in the upsidewith them. At the end of the year when wereview performance, we look at how eachanalysts return on capital compares to theopportunities presented by the group ofcompanies he or she follows. We look athow they manage drawdowns and risk.Did they make their money broadly or injust a few names? Did they communicateeffectively? Did they learn from mistakes?

Are there particular businesses or sectorsthat tend to attract you?

LC: For the most part, well look at anysector of the market. Technology isnt atthe top of our lists usually, but we do ownCisco, Microsoft, Oracle and Corning.With the exception of Corning so far,which well speak about later, these haveall been very good stocks for us.

This isnt unique to us, but we wantcompanies with large amounts of freecash flow, good business dynamics, aproven ability to profitably reinvest thatcash flow and management properlyincentivized to do the right thing forshareholders. We generally focus on busi-nesses that are two-cycle tested, wheretheyve been through a couple recessionsand have survived intact.

You generally wont see us buy thingsthat have been up 50-60% we figuresomebody else already made the money onthose. A company like [floor-coveringsmaker] Mohawk Industries, which has alot of free cash flow and a CEO, JeffLorberbaum, who has done a great job ofreinvesting that cash flow, wed probablyown if the stock was in the mid-$60s, butnot at the $75-76 at which it trades today.

Do you consider yourself an activistinvestor?

LC: We dont look to go into underper-forming companies and try to get them to

change their ways, but we have no qualmsabout making our views known whenthings are being done that we dont agreewith. When [power wholesaler] Mirant[MIR] announced a tender offer at a 30%premium for NRG Energy earlier thisyear, we said very publicly that it makesabsolutely no sense to use auction-marketstock trading at a big discount to our view

of its value to pay private-market valuefor another company. [Note: Mirant with-drew the acquisition proposal in June.]

We own Bed Bath & Beyond [BBBY],which is arguably one of the best retailersin the country, and I have tremendousrespect for the way they run their busi-ness. But we think theyre too debt-averseand should take on debt to buy up to25% of their stock. They have short- andlong-term cash of $1.4 billion withalmost no debt, while they generate in atypical year $400-450 million of free cashflow, which is growing. We have a veryopen conversation with them about this,they just havent listened to us yet.

An example of good activism by oth-ers, I should say is what happened withKerr-McGee, which has been my best per-former this year. I couldnt get the compa-ny to see the virtue of buying back stock,but when Jana Partners and Carl Icahnlaunched a proxy fight, the companyresponded by shedding assets andannouncing a big share buyback. A yearlater they announced another $1 billionbuyback on their own and then ended upselling the company to AndarkoPetroleum for a big price, well above theprice at which they bought back stock.Theres no question, and they will tell youthis, that a key reason they got the pricethey did was by shrinking their cap baseat the right time.

Sometimes being an activist can takemore effort than its worth. Four yearsago we gave up on Tenet Healthcare, sell-ing our entire position at about $35, afterthey made a series of stupid decisions.The final straw was when they boughtback $1 billion in stock and said at thesame time that the companys outlookwas too uncertain to provide earningsguidance. I said to them, I can respectthe fact that youre not providing guid-ance, but why are you buying back $1 bil-lion worth of stock if the outlook is souncertain. Duh! [Note: Tenet sharescollapsed in late 2002 and currently tradeat around $7.]

What other things prompt you to sell?

LC: The highest-quality reason is whensomething reaches our price objective.When energy got to be too much of ourportfolio and some of the companiesstarted hitting our price targets, we sold afew, like Royal Dutch Shell and [coal pro-ducer] Consol Energy. A second reasonwe sell, as it was with Tenet, is to cut ourlosses short if somethings not moving inthe direction we expected. I tell my peopleto be in touch at least every couple ofweeks with all their companies, to getwhatever indication possible on howtheyre tracking versus expectations.

The third main reason to sell is whenwe identify other ideas with betterrisk/reward characteristics. A recentexample was selling Time Warner becausewe thought News Corp. was more attrac-tive. Finally, as we discussed earlier, whenour market view changes, we sell to makeadjustments in our asset allocation.

Your equity portfolio tends to be quitediversified. Why?

LC: Diversification is an important part ofour risk management. Average individualpositions range from 1-2%, with thelargest core positions at 4-5%. In 15 years,weve had three positions that got as highas 8%, two that worked out very well andone, Tyco, that was a disaster at the time.With Tyco, we thought the market wasbeing irrational and were buying on the



ON BED BATH & BEYOND:

I have tremendous respect for

them, but theyre too debt-

averse and should buy up to

25% of their stock.

way down before the scandal really hit.An important percentage of Omegas

total capital is our own money and werejust trying to do what we think is intelli-gent in a highly uncertain world. I dontknow how some of these young hedge-fund guys do it, being 160% gross longand 40% net long. Im not questioninganybody, but if youre running a lot of cap-ital, to be that gross long you have toeither have enormous positions where yougive up liquidity or you have to have anincredible number of positions, too manyto follow effectively. Our level of diversifi-cation reflects our unwillingness to makesuch giant bets or to give up liquidity. Wecould liquidate our portfolio in 48 hours.

Describe the opportunity youre findingin quality-growth companies.

LC: As I mentioned earlier, we often findopportunity when our view of the valueof a company's growth prospects differsfrom the market's, which is the case todaywith some very high-quality companies.

Michael Freedman: Stocks go up for oneof two reasons: growth or multipleexpansion. Growth investors who are notprice sensitive are playing for businessgrowth. Value investors often play formultiple expansion and are not overlyconcerned with growth. We try to lookfor situations where you can benefit fromboth that gives you two ways to win.

Good, growing businesses tend to becheap either because theyre overlookedor out-of-favor. With our asset size, weremore likely to put capital to work in high-quality growth companies that are out-of-favor and in Mr. Markets penalty box.Fortunately, short-term, momentuminvestors can drive down growth-compa-ny share prices, providing plenty ofopportunity for those with a longer-termfocus to buy on the cheap.

Lets talk about one of the specific growthcompanies you see as out-of-favor,Corning [GLW].

MF: Cornings biggest and highest-profilebusiness is providing the glass used in

making screens for a wide variety of con-sumer electronics, most importantly liq-uid-crystal-display monitors and TVs.Consumer adoption of LCD TVs is nowhitting its acceleration zone, as pricescome down. I looked up and down theindustrys food chain for the best way toplay this explosion in consumer adoptionand landed on two areas supplying theliquid crystal and supplying the glass forscreens. In each case there are very fewsuppliers and the manufacturing processis very difficult, making the potentialupside very interesting as demand grows40-50% per year.

The LCD panel itself is essentially a

sandwich, with two sheets of glass and allthe electronics and lighting behind it. Theglass Cornings business has to beabsolutely perfect, with no deviation inthickness or any imperfections through-out the entire panel, and it has to be ableto withstand high temperatures in thefabrication process.

Given how hard that is to do, there areonly three main players in the market:Corning, with 60% of the market, fol-lowed by two Japanese competitors,Asahi Glass and Nippon Electric Glass.Corning has been the technology leader,which gives them a pricing advantageuntil the competitors catch up. Theyre



Corning(NYSE: GLW)

Business: Manufacturer of glass-basedproducts with applications primarily in con-sumer electronics, telecommunications, lifesciences and environmental control.

Share Information(@ 11/29/06):

Price 21.4952-Week Range 17.50 29.61Dividend Yield 0.0%Market Cap $33.62 billion

Financials (TTM):

Revenue $5.01 billionOperating Profit Margin 15.2%Net Profit Margin 6.1%

THE BOTTOM LINE

As the market-share and innovation leader, Corning is ideally positioned to profit frombooming consumer and industrial demand for liquid-crystal-display glass, says MichaelFreedman. He believes that at a more appropriate 20x multiple of estimated 2008earnings of $1.50 per share, the shares within a year should be worth around $30.

I N V E S T M E N T S N A P S H O T

GLW PRICE HISTORY

Sources: Company reports, other publicly available information

30

25

20

15

10

5

30

25

20

15

10

52004 2005 2006

Valuation Metrics(Current Price vs. TTM):

GLW S&P 500P/E 28.4 20.4P/CF 33.7 14.4

Largest Institutional Owners(@9/30/06):

Company % Owned

Fidelity Mgmt & Research 7.0%Capital Research & Mgmt 4.8%Wellington Mgmt 3.5%Axa 3.1%Barclays Global Inv 3.1%

Short Interest (@ 10/9/06):

Shares Short/Float 1.1%

also the most flexible and cost-efficientmanufacturer and their glass runs up to15% more efficiently through the cus-tomers fabs. Thats why theyve beenable to maintain market leadership andanother reason they get premium prices.

What is the market concerned about?

MF: Some of it has been over the timingof seasonal orders, which I think is irrele-vant. There may be variability in con-sumer and therefore TV-manufacturer demand, but it has no effect on longer-term demand for LCD glass.

The market also seems very concernedabout pricing. Every year the price of LCDglass on a per-inch basis goes down, as istypical in consumer-electronics businesses.This year the price per-inch will probablybe down about 15%, which is more thanthe market expected. I dont consider thata big deal for two reasons. One, a big partof this years decline came from Asahi andNippon catching up in quality in certainglass sizes, wringing out some of the pre-mium Corning was able to command inthose sizes. To the extent the premium hasbeen wrung out in those products, it cantbe wrung out again, so theres no reasonto consider the 15% price drop a trend.

Second, Corning seems to get little cred-it for that fact that theyve been reducingmanufacturing costs in the mid-teens also.This highlights one of their primary com-petitive advantages: they spend 10% ofsales on research and development, work-ing on both inventing the next big thing aswell as driving down costs of existingproducts. Thats a lot more money onR&D than their competition can afford.

How attractive do you consider Corningsother business lines?

MF: LCD glass is the major driver today,but I consider the two other main busi-nesses to be excellent call options for thefuture. The telecommunications businessis basically a play on more optical fiberbeing employed. During the Internet bub-ble, a lot of long-haul fiber was laid, but itcant be taken advantage of until newshort-haul connections utilizing Corning

products are in place. As demand forInternet video increases, youre eventuallygoing to need that fiber capacity available.This business is breakeven now, but iforders picked up it would be very prof-itable, very quickly.

Their other interesting business ismaking emissions-control products forcar and truck engines. New environmen-tal regulations in Europe and the U.S.requiring cleaner-burning diesel enginesin heavy-duty trucks go into effect on

January 1. The rules basically require ascrubber on the engine and Corning hasthe best product on the market. Theyrebooking small revenues now, but havesigned deals that will show up materiallynext year. Corning believes this can be a$500-600 million revenue business withinthe next few years, and they tend to guideconservatively.

More generally, Cornings heavyspending on R&D would suggest theymay have several blockbuster products intheir labs right now, from things like solarcells, green lasers or ultracapacitors.

Trading recently at around $21.50, howare you looking at valuation?

MF: The company trades at about 16xconsensus 2007 earnings estimates, whichI think are conservative. If you look at 20of the best name-brand technology com-panies, like Cisco, Nokia and Microsoft,the median P/E on next years earnings is17.9x and the median expected long-termannual growth estimate is 14.6%. SoCorning is trading for a lower multiplewhile its consensus growth estimate ishigher, at 17.3%.

Looking to 2008, I think the companycan earn north of $1.50 per share. At the

18-20x multiple a company with thesegrowth characteristics should have, wehave a target price for next year ofaround $30.

Another blue-chip attracting your atten-tion is 3M [MMM]. Why?

Mark Cooper: 3M is a large industrialconglomerate whose specialty is utilizingchemistry and materials science for a widevariety of purposes, often involving apply-ing coatings to some kind of surface. Theirbest-known products are Post-it notes andScotch tape, but that division makes uponly about 15% of revenues. They havesix different business units, serving a widevariety of consumer, commercial andindustrial markets. For example, the dis-play and graphics business applies filmover any type of screen to enhance bright-ness or improve the viewing angle.

Its very much a company driven byintellectual property. It generates amongthe highest number of patents annuallyand BusinessWeek earlier this year rankedit #3, behind Apple and Google, on theirlist of the worlds most innovative compa-nies. The fact that its researchers canspend approximately 15% of their timedoing what interests them is an importantpart of the company culture and a sourceof its competitive advantage.

Youve said the company is currently mis-understood. What do you mean?

MC: With all the different business unitsand industries, its very hard to analyze3M at a micro level. Perhaps thats whythe market seems so unenthusiastic aboutthe company. I was at an investment con-ference in New York a few weeks ago andGeorge Buckley, 3Ms CEO, made a pres-entation. It was supposed to be mostly aQ&A session, but only two people askeda question and I was one of them.Afterwards, only one other investorjoined me on the stage to speak with Mr.Buckley. This is a $60 billion market-capcompany and I could spend a month withthem and not know half the detail Idwant to learn about their businesses, butno one had any questions.



ON 3M:

That researchers can spend

15% of their time doing what

interests them is a source of

3Ms competitive advantage.

The opinions that seem to be drivingthe market price dont match reality. Forexample, there seems to be an increasingfear that the companys growth prospectshave diminished, but if we look at the lastthree years of sales growth, its close tothe long-term average. The most recentyear sales growth wasnt great, but I dontat all consider that a permanent trend,primarily due to growth potential over-seas, particularly in Asia. The companycurrently gets just over 60% of revenuesfrom outside the U.S. that should be70% within the next five years. Im con-fident they can at least hit their overalltarget of 8% annual organic sales growth.

Theres also concern that the companywill overemphasize growth at the expenseof margins. I think that concern is exag-gerated for a few reasons. One, theyregrowing incrementally faster overseas,where theyve historically earned highermargins. I also believe theres consider-able inefficiency in their manufacturingand logistics operations. Over 50% of theproducts 3M sells go through at leastthree of their factories, which is shocking.Attacking those inefficiencies and takingcosts out will obviously benefit margins.

Despite these issues, margins are cur-rently at all-time highs gross marginsare over 50% and EBITDA margins are

close to 30%. Even if the company didsacrifice some margin to grow faster incertain areas or devote even more thanthe current 5-6% of revenues to R&D,that would likely be a positive from a net-present-value perspective.

How is the markets seeming lack ofenthusiasm showing up in the share price,which is currently around $81?

MC: Almost every valuation metric todayis at a multi-year or all-time low, whichcontrasts with the growth potential andthe returns on tangible capital this com-pany earns, which are consistently over50%. The P/E is close to a 15-year low,price-to-book a 10-year low, price-to-sales a six-year low and the dividendyield, at 2.3%, is the highest its been ineight years.

If the company does just what the mar-ket expects, which is to earn $5 per sharenext year, I believe they deserve a 20x P/Emultiple, which is appropriate for a busi-ness that should produce consistent 15%annual growth in earnings per share whilegenerating extraordinary returns on capi-tal. That puts our target price next year ataround $100. If 3M does what we believeit can do over time on the growth side,the upside is much more than that.

LC: One thing Id add here is that the com-pany has a ridiculously unleveraged bal-ance sheet it ought to buy back $2-4 bil-lion of common stock immediately at cur-rent prices. One reason we own it is thatwe expect a very significant cap shrink.

Tell us about one of your current health-care bets, Omnicare [OCR].

David Mandelbaum: Omnicare is thenations leading provider of pharmacyservices to the long-term-care industry,primarily nursing homes. They have cen-tralized dispensing and packaging facili-ties and also provide a variety of servicesbeyond just filling prescriptions thingslike making sure people are taking theirmeds and arent having any adverse druginteractions. After buying NeighborCarelast year, they have approximately 50%



3M Company(NYSE: MMM)

Business: Diversified conglomerate spe-cializing in applying chemistry- and materi-als-science-based solutions to consumer,commercial and industrial needs.



Financials (TTM):


THE BOTTOM LINE

Market concerns over diminished growth prospects and margin pressures areoverblown, says Mark Cooper, who expects overseas growth and cost savings to fuelconsistent 15% annual earnings growth. At a 20x multiple of the consensus 2007EPS estimate of $5 per share, he believes the shares are worth at least $100.


MMM PRICE HISTORY


100

80

60

100

80

602004 2005 2006


MMM S&P 500P/E 17.7 20.4P/CF 13.2 14.4


Company % Owned

State Street Corp 7.4%Barclays Global Inv 3.0%Vanguard Group 2.6%Fidelity Mgmt & Research 2.1%Capital Research & Mgmt 2.0%



market share, far ahead of PharMericaand Kindred Pharmacy, which now them-selves are merging into a new, independ-ent company.

This is a business that is all about scaleand market share. Ominicare has cost,price and distribution advantages frombeing #1, which gives them superiorEBITDA margins in the 11-12% range.PharMericas are around half that.

The stocks been a bit of a disaster thisyear, off more than 35% to a recent $39.What are the primary reasons?

DM: Several things have been weighingon the stock. First, the industry is under-going a dramatic transition. Omnicarehad previously been largely a Medicaidprovider, but this year, with the newMedicare Part D program for prescriptiondrugs, all seniors who qualify for bothMedicaid and Medicare much of thenursing-home population are now cov-ered under Part D. With that, instead ofbeing price takers of state Medicaid agen-cies for drugs and dispensing, Omnicarenow negotiates separately with all the pri-vate Part D plans, such as HMOs or phar-macy-benefits managers that are licensedunder Part D. While change causes uncer-tainty, I generally look at this as a long-term positive. As the only truly nationalprovider, Omnicare has been able to getbetter pricing from the large private plansrelative to what it had under Medicaid.

Second, theres been an overhang prob-lem because of some investigations intoOmnicares practices. The state ofMichigan went after them over billingerrors it discovered and the federal govern-ment and 42 states sued them over someirregularities in documenting the substitu-tion of generics. Both of these have recent-ly been settled, and while the market hastended to view these as potentially indica-tive of a larger problem, we generally con-sider these to be isolated situations that areinevitable when operating in such a com-plicated regulatory environment.

The third thing worrying the market isa pricing dispute with UnitedHealth.United covers about one-third of the dual-eligibles now getting their prescriptions

paid under Part D. Omnicare negotiatedgreat rates with United, but then Unitedacquired PacifiCare, with whichOmnicare had a less attractive contract.United then started moving its dual-eligi-ble members over to the PacifiCare con-tract, which, if it sticks, would result in a40-cent hit to Omnicares annual earningsper share. Omnicare has sued them overthat, and while Im not counting on it aspart of my investment thesis, I think itsmost likely there will be a positive resolu-tion of this for Omnicare, which would bea great catalyst for the stock.

Fourth, the company has been hit withsignificant extra costs which we clearly

see as non-recurring in the second halfof this year, due to a fire that closed oneof its two main repacking facilities.

Last, but not least, Democrats takingover Congress has been a negative forhealthcare stocks of all kinds.

What upside do you see for the shares?

DM: In investing in any business, but par-ticularly relevant to healthcare, you makemoney when you can separate the noisefrom the fundamentals. When the funda-mentals are strong and improving, as theyare with Omnicare, the noise can createan exceptional opportunity.



Omnicare(NYSE: OCR)

Business: Provider of pharmaceuticals andpharmacy services to long-term healthcareinstitutions such as nursing homes, primari-ly in the United States and Canada.



Financials (TTM):


THE BOTTOM LINE

David Mandelbaum doesn't believe the recent events weighing on Omnicare sharesthreaten the company's strong and improving business fundamentals. Once the marketsees through all the clouds, he expects the shares to return to their historical 17xmultiple of forward earnings, which would result in a share price of at least $54.


OCR PRICE HISTORY


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OCR S&P 500P/E 28.8 20.4P/CF 16.9 14.4


Company % Owned

Fidelity Mgmt & Research 14.6%Glenview Capital 7.2%T. Rowe Price 4.7%JPMorgan Chase 3.5%Barclays Global Inv 3.1%



Omnicares earnings power is verystrong. Theyre getting higher margins ongenerics, which are taking market share.Other than with UnitedHealth, better pric-ing is locked in for next year. We see sub-stantial cost-saving opportunities from theNeighborCare acquisition and efficiencyinitiatives now underway. There are alsohundreds of acquisition opportunities forthem among smaller players who cantcompete in an increasingly scale-drivenbusiness, and such deals have generallybeen extremely accretive.

We estimate on the low end theyllearn $3.20 per share next year, versus theWall Street consensus of $2.90. Theycould do even better than our estimate ifthe United case gets settled in their favor.

So the shares are trading at just over12x next years earnings, vs. an historicalaverage of around 17x. Once the marketsees through all the clouds and startsfocusing on how well the company is posi-tioned and the mid-teens annual growth inearnings it can produce, we see no reasonthis shouldnt return to its historical mul-tiple. At 17x, this is a $54 stock.

What are the biggest risks here?

DM: If were going to be wrong, its mostlikely to be from some market change, sayMedicare cutting Part D rates or plansponsors squeezing them on pricing. Wedont believe either is going to happen.

Youre still heavily invested in energy.Describe one of your favorites in the sec-tor, Transocean [RIG].

LC: We do still like energy, which current-ly makes up about 15% of our portfolio.We find energy-sector valuations to beattractive and expect high free-cash-flowlevels to help fund buybacks, dividendincreases and the de-leveraging of balancesheets. Having come down from specula-tive levels of a few months ago, we thinkan oil price of $50-60 per barrel is funda-mentally defensible and that the secularsupply/demand environment is favorable,with global oil demand growing up to 2%per year, while global supply growth is1.5% or less. Despite extremely high oil

prices, youre not seeing production growat the majors its actually declining.

Oil prices are at a level thats morethan sufficient to generate good capitalspending in the sector, which particularlybenefits services firms like Transocean.They own about 35% of the worlds sup-ply of fifth-generation deep-water drillingrigs and have the most-sophisticatedequipment, the best technology and thebest-trained personnel to man the rigs.And, there is an acute shortage of supplyin these rigs, which will not change untilaround 2010. Thats an excellent combi-nation: Youve got the best mousetrap intown, and mousetraps are in short supply.

As weve seen recently with the largediscoveries in the Gulf of Mexico, deepwater, which is economic at prices as lowas $40 per barrel, is where all the devel-opment prospects are. Given that weagree with Boone Pickens who made allhis money trading oil when he says heexpects to see $70 oil again before he sees$50, we think Transocean trading on 50-cent moves in the price of oil is silly.

Isnt the rig business famously prone toovercorrecting on the supply side?

LC: Were the first to acknowledge that,but given that youre not going to see new



Transocean(NYSE: RIG)

Business: Global provider of offshorecontract-drilling services for oil and gaswells, with a focus on deep-water andharsh-environment drilling.



Financials (TTM):


THE BOTTOM LINE

As the leader in deep-water drilling services, Transocean has the best mousetrap intown, and mousetraps are in short supply, says Lee Cooperman. Just by gettingcredit from the market for the $12 billion in cash earnings he expects from backlogorders through 2010, he believes the shares are worth at least $100.


RIG PRICE HISTORY


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Company % Owned

Capital Research & Mgmt 5.2%Davis Selected Advisers 3.2%Fidelity Mgmt & Research 3.0%State Street Corp 2.8%Vanguard Group 2.8%



deep-water rigs in any volume before2010, we think that risk is already morethan in the stock.

Another risk would be if the holes startcoming up dry. These rigs lease out for$500,000 per day, so if theyre not find-ing oil, theyre obviously not going todrill. We see no evidence that will be aconstraining factor.

At around 78.50, the shares are off near-ly 15% from their May high. What doyou think theyre worth?

LC: Given the backlog from now until2010 all from orders by triple-A anddouble-A companies and countries theirbusiness is reasonably locked. They havea funded backlog of over $20 billion,which will convert into about $12 billionof cash in the next three and a half years.That $12 billion in cash is about $40 pershare. Just getting credit for the cash flowthats already basically in the bank, webelieve the shares are worth at least $100.

Supporting the price is the fact thattheyre using some of their enormous freecash flow to buy back shares. Theyveauthorized $4 billion in buybacks andhave already bought in $2.6 billion worthso far this year.

Are you making any important macrobets, as you described them earlier?

LC: We have a position right now inJapans Nikkei index. The S&P 500 is uparound 12% this year, Europe is up 13-14% and the Nikkei is so far down about2%. Japan has significantly lagged majorworld markets, yet they have a cheap cur-rency, which is very positive for the profitoutlook, and they have a 0%-interest-ratepolicy, which is very positive for multiplevaluations. You have a growing economywith world-class companies, while corpo-rate profit margins are low relative to therest of the world, so theres more room forimprovement. Youre coming off a 15-year bear market and common sensewould tell you theres more to go on theupside than two or three decent years.Finally, given the proximity to China, Iexpect more to fall off Chinas plate intoJapan than into the U.S.

Youve been at this for 40 years. Do youexpect to keep it up for another 40?

LC: I still enjoy the game, making bets onsomething other people dont see andhaving Mr. Market prove me right.

Ive said since I started in the business

that three things would get me out of it.One is a medical issue and, knock onwood, I feel fine and have a lot of energy.Second is if I stopped delivering perform-ance that is acceptable. My investor baseis very committed to me and they knowme personally I dont want anyone stick-ing with me unless Im delivering highlycompetitive performance. Third, Ill stopif I dont still enjoy it. Thats the only onethats becoming more of challenge.

Why?

LC: The people side of things can be dif-ficult. Im unusual in this business. I spentmy career at one firm before setting outon my own and have always been inter-ested in being long-term selfish, not short-term selfish.

Ive hired people for $50,000 a year,three years later paid them a multi-mil-lion bonus and then had them quit tomake more money. Its pay me, pay me,pay me if I do well and if I lose money, Illsee you later. I cant bemoan the waythings are, the system has treated me verywell. But people should recognize that itsa vacuum in nature, not some God-givenright, thats created the opportunity tomake the money that we do. VII



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I N V E S TO R I N S I G H T : Charles Akre

Your investment philosophy has beeninfluenced as much by Warren Buffett theCEO as by Warren Buffett the investor.Describe how that came about.

Charles Akre: I was fascinated by JohnTrains The Money Masters in the mid-1970s, the first chapter of which was onWarren Buffett. I became the best studentof Buffett I could and first boughtBerkshire Hathaway shares when it had a$100 million market cap. From that happyexperience, it became clear to me that thebest way to see if a business is addingshareholder value is by the growth in itsbook value per share. You have to makeadjustments for different industries or forissues with GAAP accounting, but Imlooking for growth in the companys trueeconomic value per share over time.

What surprises me today is the numberof CEOs and CFOs who are focused onother things growth in new stores or theshare price or their options. When I meetwith management, I dont ask aboutgrowth in book value because I want to seeif they get there on their own. Few do.

I look at it this way: The average annu-al total return from equities over long peri-ods of time has been around 10%. Whenyou clean up the accounting, the realreturn on equity [ROE] of American busi-ness averages in the low teens. So our con-clusion is that a stocks return will approx-imate the companys ROE over time, givena constant valuation and absent distribu-tions. So we choose to swim in the pool ofcompanies where the returns are a wholelot better than average, in the 20% range.

Historical returns obviously dont guaran-tee future returns. How do you separatethe future winners from the has-beens?

CA: We focus on three things: businessmodel, people and reinvestment capability.

In companies earning abnormalreturns, theres something unique going onand we want to understand what it is,why it exists and whether its sustainable.Were trying to find businesses that havegreat moats, which translates into greatreturns on capital. Moats are fairly rarebut come from a variety of things, such asregulation, intellectual property, sustain-able cost advantages and superior man-agement. True moats give you more confi-dence in projecting future performance.

We next focus on management. Im ata stage in my career where Id say humanbehavior is the most important determi-nant of a businesss long-term success. Idont care how smart an analyst you are,you cant really know whats going oninside a business. We want to invest notonly in highly capable managers, but alsothose with clear track records of integrityand acting in shareholders best interest.Ive found that when a manager puts hishands in shareholders pockets once, hesmuch more likely to do so again.

Do you ever buy a great business with anot-great management, expecting change?

CA: We generally dont invest in brokenbusinesses that need to be straightened outor bad people that need to be thrown out.Its just not what we do.

Our third focus is related to the firsttwo: Because of the nature of the businessand the skill of management, were look-ing for companies that can reinvest whatwe expect to be excess cash in a way thatearns unusually high rates of return. Thiswas the case with Berkshire Hathaway,which created a compounding machine.

How does valuation come into play?

CA: On top of everything we apply oursophisticated valuation methodology,

Investor Insight: Charles Akre


Akre Capitals Charles Akre describes why moats are so central to his investing style, why he's not big on diversification, whyhigh valuation is rarely the reason he sells and why he sees undiscovered value in Penn National Gaming, Markel Corp.,American Tower, O'Reilly Automotive and 99 Cents Only Stores.

Charles Akre

Long and Winding Road

Having earned an English Literaturedegree from American University, ChuckAkre took a practical approach to his inde-cision about a career: I took a series ofvocational aptitude tests which indicated Ishould be a stock broker or stock analyst,he says. I truly didn't know the differencebetween the two then.

Starting as a retail broker at Johnston,Lemon & Co. in 1968, Akre over 21 yearsthere became a shareholder in the firm,director of its research department andCEO of its investment-management divi-sion. He started Akre Capital in 1989 tomanage separate accounts and a hedgefund and teamed in 1997 with Friedman,Billings, Ramsey & Co. to launch the FBRSmall Cap mutual fund, which he stillmanages and which earns a five-star rat-ing from Morningstar.

Akre now works out of an office in rusticMiddleburg, Virginia, not far from his farmat the foothills of the Blue RidgeMountains. I had an atypical start in thisbusiness and it's taken a long time to getto where I am now, says Akre. Curiosity,hard work and more than a little luck goesa long way.

which is basically Were not willing topay very much. We typically buy compa-nies with higher returns on capital, bettergrowth, stronger balance sheets and lowerempirical valuations than the overall mar-ket. We think its intuitive that if we get allthese right, our return should be higherthan that of the market, with what webelieve is a lower level of risk than themarket.

The opportunity to buy usually comesdown to a significant diversity of opinionin the market. Its good for us when WallStreets opinion differs from ours, whichallows us to buy at attractive valuations.

We really dont pay that much atten-tion to why something is undervalued. Ifwe buy companies in which shareholderscapital compounds at a 20% rate ofreturn over a reasonable time period andwe pay a below-average multiple for it,our investors will do extremely well.

How would you define your circle ofcompetence?

CA: We focus on service businesses, ingeneral, because the fixed assets requiredto produce revenue are smaller. Ive donewell over the years in recreation and enter-tainment businesses, property/casualtyinsurance, and banks and other financialinstitutions. We have larger investmentstoday in retail than weve had in the past theyre relatively easy to understand,which is key for me.

Do you have any cap-size restrictions?

CA: Its axiomatic that when businessesare smaller, the opportunities for com-pounding at a high rate are greater, so wemay be somewhat more likely to be insmall- or mid-caps.

I would say I dont get overly con-cerned with how my portfolios are catego-rized. Our mutual fund [the FBR SmallCap fund] was originally called a valuefund, then it was a core fund and nowit shows up sometimes as a growth fund.Through all that, we havent changed any-thing we do since day one the notionthat growth is a creator of value is animportant part of how we invest.

Describe the distinction you makebetween what you call core and work-bench positions.

CA: Ive never been so disciplined that Ihold off buying until 100% of the work isdone. A workbench position gets builtinto a core position only when we have lit-tle or no question about the business, peo-ple and reinvestment opportunities. Ittakes time to learn how the businessmodel really behaves and Ive also found

that it usually takes a long time to under-stand when management is really good.Many of the times I thought I knew rightaway, I was dead wrong.

An example of a workbench holdingthat has been that way for some time isAmeriCredit [ACF], a sub-prime autolender we bought in 2002. We got into itafter they had some credit problems andthey changed their accounting from gain-on-sale to more cash-based, making theirGAAP earnings nearly disappear. Webought originally around $7, down to aslow as $3, and theyve done a great job ofgetting the business back on track. [Note:AmeriCredit shares currently trade at$23.50.] But Ive never upgraded it to acore holding because Im still uncertainhow their customers will behave in a morecredit-restricted environment. Its a busi-ness-model issue that keeps me from fullycommitting to it as a core holding.

Your have 65% of your hedge fund port-folio in the top seven holdings. Why soconcentrated?

CA: If I didnt have partners, the concen-tration would be even higher. You knowhow much of Warren Buffetts partnershipwas in American Express when he bought

it after the DeAngelis salad-oil scandal?40% or so. [Editors Note: In the early1960s, commodities trader Tino DeAngelisattempted to corner the market for soy-bean oil, which was used in salad dressing.His elaborate scam involved taking outloans many from an American Expresssubsidiary against what turned out to benon-existent soybean-oil inventory. Whenthe fraud was uncovered, AmericanExpress suffered significant losses on theloans, driving down its share price.]

If you think about individual wealthcreation in this country, it almost alwayscomes from a single asset. A companycompounding capital at way above-aver-age rates, when I have great confidencethat will continue and the valuation ismodest, I want to own a lot of that. Therationale is that simple.

Tell us about your largest holding, PennNational Gaming [PENN].

CA: Penn National is primarily in thebusiness of operating slot-machine venues on land and on riverboats in thirteenjurisdictions around the country. Theyreonly in regional markets, with no positiontoday in Las Vegas or Atlantic City. Theyalso have racetrack licenses in WestVirginia and Maine.

When we first got involved with thecompany ten years ago, it was mostly inthe off-track betting business, which hadvery little reinvestment opportunity. Thatled them to get into running slot machinesat racetracks and then buying more tradi-tional casinos. They have an excellent his-tory of acquiring casinos and makingimprovements in their return on assets.

Whats attractive about the business?

CA: I like that they see their profits incash, every day. Once venues are estab-lished, they benefit from barriers to entryfrom the strict licensing issues surround-ing gaming. On the demand side, its driv-en by human nature and the fact that largedemographic groups see playing the slotsas three or four hours of entertainment,for which theyre more than willing to pay$50 to $100. Theres a lot of activity,



ON CONCENTRATION:

A company compounding capi-

tal at way above-average rates

when the valuation is modest, I

want to own a lot of that.

camaraderie in going with friends, andpretty good food. Thats an attractivevalue proposition for many people.

All of this makes it an inherently high-return business. In the ten years weveowned Penn stock, book value has com-pounded at more than 40% per year.

Whats driving future growth?

CA: With existing assets, they continue todo a great job of expanding when theycan. In Charles Town, West Virginia, theystarted with a racetrack and 154 slotmachines and now have 4,200 slots, withapproval to go to 6,000. In

Lawrenceburg, Indiana, across fromCincinnati, theyre adding a new riverboatand parking garage to an existing venue.

Many existing assets are relativelyfinite, though, so theyll have to acquiremore. They continue to make selectiveacquisitions of individual properties and Isee several public companies that wouldbe great fits, at the right time. If theopportunities dont materialize, theyllhave a tremendous amount of capital toshrink the share base.

This is a perfect example of where myconfidence about reinvestment potentialhas a lot to do with management. I remem-ber meeting Peter Carlino, who is still the

CEO, in the 1990s in Boston. I could see afew things right away, including that hewas very ambitious and had a high level ofself confidence. His background was inreal estate development, so I knew hisambition would likely result in his takingon a lot of debt. But one thing that stuckwith me from that conversation was howin all his real-estate deals, hed never hadhis wife on a note. Thats almost impossi-ble to do as a small developer the bankswant your first child. It told me he had anacute sensitivity to risk. Over time, as hemade acquisitions and built the company,that sensitivity has translated into veryhigh standards for the returns he requiresfor the risks he takes.

Hasnt Penn been particularly generouswith stock options?

CA: Theyve given options at a good clipand Peter takes the most, which I dontagree with, but he and his family are thelargest shareholders and thats whattheyve chosen to do. It doesnt take awayfrom the fact that hes created enormousvalue for all shareholders over time.

With the shares currently around $37,how are you thinking about valuation?

CA: The shares trade at 11x our $3.40estimate of 2007 free cash flow per share thats after all maintenance capitalspending as we understand it. If were cor-rect that the company can continue tocompound book value at a high rate 20% or greater over the next five yearsand we only have to pay 11x to get it, likeI said, well do very well. Thats why thisis nearly 20% of my portfolio.

What are the biggest risks you see here?

CA: Gaming revenue to various jurisdic-tions is like crack cocaine they alwayswant more so the risk is that taxes willkeep going up on casino revenue, as theyhave in Illinois, for example. In some cases,local and state taxes are as high as 50%.

New jurisdictions will also open up,bringing some new competition to existingvenues. I just assume there will always be



Penn National Gaming(Nasdaq: PENN)

Business: Operator of casino and horse-racing facilities, with a primary focus on slotmachines. Currently in 13 jurisdictions,though not in Atlantic City or Las Vegas.



Financials (TTM):


THE BOTTOM LINE

Through organic growth and timely acquisitions, Chuck Akre expects Penn National tocontinue expanding its book value per share by at least 20% annually over the nextfive years. Trading at only 11x his $3.40 estimate of 2007 free cash flow per share, heexpects the share price to compound at least as quickly as book value.


PENN PRICE HISTORY


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PENN S&P 500P/E 20.4 20.4P/CF 11.6 14.4


Company % Owned

Fidelity Mgmt & Research 11.7%Akre Capital 8.5%Friedman, Billings, Ramsey 4.7%Bamco 3.9%Munder Capital 3.3%



new competition, as there has been for thepast 10 years. While thats a risk, its alsoan opportunity for an experienced opera-tor like Penn to open up new markets.

Why is Markel Corp. [MKL], anotherlong-time holding, still attractive?

CA: Weve actually owned Markel since1990. They operate primarily in whatscalled the E&S (Excess & Surplus)insurance market, covering hard-to-placerisks that arent included in the standard,regulated forms that exist in every state.They have more than 90 different lines ofinsurance, including things like liabilityfor summer camps, earthquake and hurri-cane protection and professional liabilityfor physicians who have had drug andalcohol problems. Not surprisingly, theytend to have very strict underwriting con-ditions and premium pricing.

Their business is no different thanmine: it comes down to people and howwell they put business on the books thatearns an underwriting profit. The proper-ty/casualty business has been plagued bylarge companies driven by volume ratherthan profitability, who expect to morethan offset underwriting losses withinvestment profits. Markel only writesbusiness for which they expect to make anunderwriting profit.

In underwriting this way, it allowsthem to be more aggressive with theirinvestments. They now have 75% ofshareholders capital invested in equities,with the expectation that has been borneout by experience that theyll have high-er investment returns than those whoinvest more in fixed-income. [Note:Markels equity portfolio is managed byThomas Gayner, whose interview was fea-tured in the May 26, 2006 issue of VII.]

What growth in annual book value areyou counting on here?

CA: Because the company has a history ofunderwriting at a profit and earning excessinvestment returns, it has an unusual bal-ance sheet. Its gearing ratio is around3.6x, meaning they have 3.6 dollars in theinvestment portfolio for every dollar of

book value. Given that, only a 5% annualafter-tax return on their portfolio results inan 18% increase in book value per share.If you put underwriting profits on top ofthat which theyve achieved in all butthree or four of the past 20 years plus atrack record of doing better than 5% after-tax on the portfolio, you can easily seethem returning over 20% per year.

Will they need acquisitions to grow?

CA: They may have to acquire premiumsto have the type of reinvestment returnsId like to see. That could come frominvesting in people to build lines of busi-

ness or from making acquisitions. Youcould argue that given the difficultiestheyve had with their last big acquisition[of Terra Nova, a European insureracquired in 2000], theres some risk inhow well theyll do with that. I think itsvery unlikely youll see them do anotherdeal that plays out like that.

Markels shares have been on quite aroll, up 40% in the past year to a recent$444. Do you still see great upside atthis price?

CA: Underwriting profits this year willlikely be anomalous, as the company got



Markel Corp.(NYSE: MKL)

Business: Underwriter and marketer ofprimarily Excess and Surplus insurancepolicies, covering less-traditional risks notincluded in standard state insurance forms.



Financials (TTM):


THE BOTTOM LINE

Chuck Akre believes Markel's underwriting discipline and skill in producing excessinvestment returns positions it to continue compounding its book value per share inthe 20% annual range. Given such growth prospects, he says, the shares are veryattractive at only 11x the $40 per share increase in book value he estimates for 2006.


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Ariel Capital 12.4%Davis Selected Advisers 4.6%Akre Capital 4.0%Fidelity Mgmt & Research 4.0%T. Rowe Price 3.5%



big price increases in hurricane areas,while hurricane losses have been almostnon-existent. But if you combine thoseprofits and the marked-to-market netinvestment gains, we expect to see bookvalue increase by around $40 this year. Soeven the current stock price is only about11x what we would call this years eco-nomic earnings, which we expect to com-pound over several years in the 20%range. As with Penn National, well getwealthy putting our money to work insuch a proposition.

American Tower [AMT] is also up strong-ly this year. Why are you still high on it?

CA: The business model here leasingwireless-communications tower capacityto operators like Cingular and Verizon is extraordinary. Once a tower is up andhas enough tenants to already operate ata terrific operational margin, revenuefrom the additional fractional tenant isadded at about a 90% gross margin.

As with gaming, this is a business withhigh regulatory barriers to entry.American Tower is building towers, butits hard to get it done on a jurisdiction-by-jurisdiction basis and even harder foranyone new to the business. When a newtower does go up, it makes little sense forsomeone to come along and put one nextto it, even if they could get approval.

Wireless technology is evolvingbeyond voice toward increased transmis-sion of video and data. Youve had therecent sale of a tremendous amount ofwireless spectrum and companies likeCraig McCaws Clearwire building anationwide wireless broadband network.All of these things currently need networkground antennae to be efficient, whichsignificantly increases demand for towercapacity. While its difficult to cite a sin-gle, unutilized-capacity number forAmerican Tower, theyre adding tenantsat a rapid clip and capacity is not yet aconstraining factor.

Another thing we like about the busi-ness is that ongoing maintenance capitalspending is actually very low. Customersgenerally pay for most of the technologyupgrades.

How is the competitive environmentchanging?

CA: The largest number of towers are stillowned by the carriers and small privateowners. Its an asset-deployment issue forthe carriers and they have been net sellersof towers to the independent companieslike American. Thats not to say Americantries to buy everything thats on the mar-ket theyve been very smart in makingfinancial judgments on assets to buy.

Crown Castle recently agreed to buyGlobal Signal, another big player in themarket, and will now be the largest inde-pendent, passing American. Americans

management points out that about 65%of Global Signals assets were formerSprint assets which were on the market and they thought overpriced a year anda half ago for $1.6 billion. Now CrownCastle is paying nearly $6 billion for all ofGlobal Signal. We think this type of think-ing by competitors plays into AmericanTowers hands.

Are there key technology risks here?

CA: Clearly, if some way is developed thatallows the wireless exchange of voice anddata without the use of ground antennae,that would be a disruptive event. From

Value Investor Insight 15November 30, 2006


American Tower(NYSE: AMT)

Business: Owner and operator of morethan 22,000 wireless and broadcast com-munications towers and rooftop sites in theUnited States, Mexico and Brazil.



Financials (TTM):

Revenue $1.08 billionOperating Profit Margin 10.0%Net Profit Margin (-9.5%)

THE BOTTOM LINE

High regulatory barriers and booming wireless demand help protect the 90% incre-mental gross margins the company earns in leasing available tower capacity, saysChuck Akre. If book value increases at the 20% annual rate he expects, paying eventhe current 25x multiple of 2007 free cash flow will pay off handsomely, he says.


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AMT S&P 500P/E neg 20.4P/CF 43.7 14.4


Company % Owned

T. Rowe Price 8.4%Fidelity Mgmt & Research 7.5%Goldman Sachs 5.7%Wellington Mgmt 5.2%Chieftain Capital 3.7%



what we can see now, theres nothing likethat on the horizon.

One risk is that another shoe dropswith respect to an options-backdatinginquiry at the company. Heres a casewhere we have to make judgments aboutthe people. Having known [CEO] JimTaiclet and [CFO] Brad Singer for quite afew years, I take it at face value when theytell me they were not involved in theissuance and pricing of any backdatedoptions. It will take its course, but I expectultimately that the biggest downside forshareholders will turn out to be thattheyve stopped an aggressive stock-buy-back program until this is sorted out.

How attractive are the shares at a recentprice of just over $38?

CA: We own a lot of shares with a costbasis of around $10, so the current priceisnt the deal it has been. It trades atabout 25x our estimate of 2007 free cashflow, but weve kept a very large positionbecause theres a high probability thecompany can compound book value atclose to 20% annually for the next fiveyears. If they compound at 20% per yearand you have to pay 25x to get that, thearithmetic still works very much in yourfavor.

By 2010, before theyre in a positionto be paying taxes, I expect there to be atransforming event for this company.Theyll convert to a REIT or someonewill buy it for the extraordinary cashflow, long-term contracts and high-quali-ty tenants.

What attracted you to your next pick,OReilly Automotive [ORLY]?

CA: We got to know OReilly and theauto-parts business through owningAutoZone and Advance Auto Parts. As anoperator, we believe OReilly has the bestmodel, with 50% of its revenues comingfrom selling parts and supplies to individ-ual do-it-yourselfers and 50% from com-mercial garages and auto-repair shops.Because of that mix, the company has ahigher concentration of distribution cen-ters relative to their stores, giving them

better in-stock positions and same-dayservice capability not only for the profes-sionals who require that kind of service but also the DIY market. OReilly serv-ices stores from a distribution center atleast five times a week, as opposed toother DIY competitors who can only do itonce or twice a week. That gives them acompetitive advantage their productsare much more likely to be in stock ordelivered within 24 hours.

Is such a system much more expensive?

CA: It works well for them their returnson equity are in the upper-teens.

Is this a growth business?

CA: The market is largely driven by thenumber of cars on the road and miles driv-en, which continue to grow. It can beaffected by gas prices or a slowing econo-my in the short term, but the underlyinggrowth trend is up.

The big opportunity for OReilly is thatauto-parts supply is still a fragmented busi-ness, with a tremendous number of mom-and-pops who are willing to sell for netasset value when one of the bigger chainscomes along. Even a bigger company likeCSK Auto [CAO], with 1,300 stores in theWest, is considered to be mismanaged and



OReilly Automotive(Nasdaq: ORLY)

Business: Domestic marketer of automo-tive aftermarket parts, tools, supplies andaccessories, targeting both do-it-yourselfcustomers and professional installers.



Financials (TTM):


THE BOTTOM LINE

As the premier operator in a consolidating auto-parts-supply business, O'Reilly is well-positioned to translate revenue and margin increases into high-teens annual earningsgrowth, says Chuck Akre. He believes such growth prospects are not all adequatelybuilt into the shares, which trade at 15x his estimate of 2007 free cash flow.


ORLY PRICE HISTORY


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ORLY S&P 500P/E 20.5 20.4P/CF 15.0 14.4


Company % Owned

T. Rowe Price 8.5%Select Equity Group 8.2%Wasatch Advisors 6.6%Ruane, Cunniff 3.7%William Blair & Co 3.6%



would make an attractive acquisitionopportunity for either OReilly or AdvanceAuto. OReilly actually has the better bal-ance sheet to do so and I believe theyremuch better, more-focused operators.

The company is opening 170 newstores this year and has been growingsquare footage 12-13% per year. If youcombine that with mid-single-digit growthin same-store sales, growing buying powerand the prospect of a large acquisition oneday, it's pretty easy to see how they can getto high-teens annual earnings growth.

At $31.50, how cheap are the shares?

CA: We think theyll earn $1.75 in freecash flow per share this year and around$2.10 next year. So the shares trade at a15x multiple, for a company growing bookvalue at least in the high teens. Again, thatsmath I expect to work out well.

Your last pick, 99 Cents Only Stores[NDN], appears to be more of a turn-around play.

CA: The company was founded in theearly 1980s and is one of the four majordollar-store chains in the U.S. Its also, bythe way, one of only two of those thatactually sells things for only $1 or less.Many of the stores youd mistake for yourlocal supermarket, with an astoundingrange of brands. When 99 Cents buys themerchandise at closeout, the big brandsknow the merchandise wont get back intothe normal distribution channel.

The news here hasn't been great. Theyentered the Texas market a few years ago,didnt get it right and have been losingmoney there. The management transitionbetween the founder, David Gold, and hisson-in-law, Eric Schiffer, hasn't gone well.They have underinvested in systems andtechnology, gone through more than oneCFO and changed auditing firms twice inrecent years, with the result that theyhaven't filed audited financial reports yetthis year.

The result of all that has been that thestock went from the mid-$30s three yearsago to under $10 a year ago. We actuallystarted our position around $14 and have

bought more on the way down. [NDNshares currently trade around $11.25.]

Where does a competitive moat comefrom in this business?

CA: Against more traditional retailers, 99Cents Only offers good value and sometreasure-hunt excitement. Within thedollar-store market, we think it offers amore attractive product mix, with fewerknick-knacks and novelty items and morefocus on food. They also have a particu-larly strong real-estate footprint in south-ern California and have proven to be moreskilled in finding closeout merchandise.

Where do you see the clouds lifting?

CA: Despite all the problems, the businessis modestly profitable and producinggood cash flow. Same-store sales are pos-itive, so customers are still attracted. Thekey problems are Texas and their back-end infrastructure, both of which are sta-bilized and showing signs of progress. Webelieve the people running the businessare smart retailers and we see no reasonwhy they can't get return on equity atleast back to the 15% range, which is farless than the company earned historically.This can be a terrific business if they exe-cute well.



99 Cents Only Stores(NYSE: NDN)

Business: Retailer of primarily name-brandfood and general merchandise priced under$1, with nearly 240 stores in California,Texas, Arizona and Nevada.


Price 11.2352-Week Range 9.47 13.88Dividend Yield 0.0%Market Cap $781.3 million

Financials (TTM):

Revenue n/aOperating Profit Margin n/aNet Profit Margin n/a

THE BOTTOM LINE

The company is poised for a turnaround after a series of operational and administrativeblunders in recent years, says Chuck Akre. By better managing its balance sheet andachieving even 50% of prior operating margins, it can earn $1.50 per share makingthe current $11.25 share price appear extremely cheap, he says.


NDN PRICE HISTORY


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NDN S&P 500P/E n/a 20.4P/CF n/a 14.4


Company % Owned

Akre Capital 9.9%Primecap Mgmt 6.8%Dimensional Fund Adv 5.5%Friedman, Billings, Ramsey 4.9%Amvescap 4.7%



How are you thinking about valuation?

CA: Hard book value is $7 per share,including a couple dollars of cash. Realestate values above stated book value they own 35 stores and two distributioncenters add another $2-4 per share. Soat a share price just over $11, we've got abook value that's 80-100% of marketvalue. On the upside, if they use their bal-ance sheet prudently and achieve even50% of prior operating margins, we cansee them earning $1.50 per share. At thatlevel of earnings, we'll make a lot ofmoney from the current price.

How patient do you expect to have to be?

CA: Weve heard from a handful of pri-vate-equity types because of the size of ourstake, which is around 10%. Ive saidwere willing to give management a chancefirst. If they can't get it right, there's likelyto be some sort of catalyst to get it right.

In general, how do you approach thedecision to sell?

CA: Valuation rarely comes into play inour sell decisions. We sell when somethingmaterially changes among the three thingswe focus on, the business model, the peo-ple or the reinvestment opportunities.

We recently sold Citigroup, for exam-ple, which originally came from a bigstake we bought in Salomon Brothersafter its Treasury-bond scandal. [FormerChairman] Sandy Weill demanded a 25%ROE from every business unit and if themanagement didnt produce, they werehistory. On one hand, that type of thing ismusic to my ears, but the other side of itwas that it didnt exactly matter to Weillhow you made your numbers. We sold,then, for a couple of reasons. First, thedriver at the top demanding high rates ofreturn from individual businesses wasgone. Second, the unwinding of all thepast bad behavior made it difficult for usto judge with confidence how attractivethe returns would be going forward.

Another example is Willis Group[WSH], the insurance broker. We had theidea after 9/11 that the insurance-broker-

age business would benefit from changesin insurance pricing and we thought Willishad an opportunity to take share fromcompetitors like Marsh & McLennan,which were much more tarnished in theprice-rigging scandal. This was a casewhere the upside just didnt ever arrive, soafter a couple years we just gave up.

CarMax [KMX] would be an exampleof something we expect to own for a verylong time, even though we wouldnt buymore at the current valuation. We love thebusiness model, the people and the rein-vestment opportunities. Its sold almostthe entire time weve owned it for north of

20x free cash flow per share, but if theyachieve their ten-year objective of growing15% per year which we believe they can well do extremely well from here.

Have you held your Berkshire Hathaway?

CA: Yes, even though its return character-istics are now lower than what were typ-ically looking for. I see it as sort of a low-teens compounder of book value with ahuge option the $40-plus billion of cashthat could allow them to make extraordi-nary purchases in an adverse time.

You mentioned the potential of activismwith 99 Cents Only. How much of anactivist do you tend to be?

CA: We want to have a regular and in-depth dialogue with management. Iveowned shares in International Speedway[ISCA] for nearly 20 years. Its an amazingbusiness model: the barriers to entry arehigh and they not only get ticket and con-cession sales from the motorsport venuesthey own, but they get the biggest portionof TV and radio revenues. For years it has

been a business with little debt and ROEsfrom the low-teens up to 25%. But myfeeling is that theyre now not takingadvantage of the quality of the businessand have been willing to accept too-lowreturns. We've had several chats withthem around this issue.

Are you active on the short side?

CA: If I'm successful investing in business-es which compound economic value pershare at a 20% rate, then our expectedannual returns are likely to be around20%, less the costs of achieving it. For 13years, the hedge fund has averaged around21%, net of all fees and incentives. Theincremental returns come from what wedo around the edges, as I call it.Sometimes it's from shorting, or making ashort-term trade or participating in anarbitrage opportunity.

With shorts, we take a lot of little bites,rather than concentrate. Were looking forbad business models, bad accounting, badpeople or bad valuations. Our short bookregularly adds to overall performance,sometimes only a little and sometimesmuch more. In 2002, it was the reason wewere up in a terrible market our shortreturns were 9% and our net returns, afterincentives, were 4.5%.

The market turning south was when youseem to have really hit your stride.

CA: At the end of 2000, the FBR mutualfund I manage was four years old and had$9 million in assets. We had a fine, butnot spectacular record. We then had pos-itive results across all our businesses dur-ing the 2000-2002 period, a time whenthe S&P 500 was down nearly 40% andNasdaq off nearly 70%. This may be themost significant achievement of my invest-ing career. When we then also had home-run years in 2003 and 2004, we reallystarted to get noticed.

What I particularly enjoy is when youcan help change the choices people havein their lives. I put my sister into sharesof Berkshire at $200 per share and shestill has them. Thats the coolest experi-ence of all. VII



ON BERKSHIRE HATHAWAY:

Its a low-teens compounder of

book value with a huge option

$40-plus billion of cash to

make extraordinary purchases.

Six and a half years ago, at whatturned out to be the very peak of theInternet bubble, famed hedge-fund man-ager Julian Robertson closed his fundwith the following prophetic words:

This is an irrational market, whereearnings and price considerations takea back seat to mouse clicks andmomentum. The current technology,Internet and telecom craze, fueled bythe performance desires of investors,money managers and even financialbuyers, is unwittingly creating a Ponzipyramid scheme destined for collapse.There is no point in subjecting ourinvestors to risk in a market which Ifrankly do not understand.

A week later, I wrote a column askingwhether Warren Buffett should also call itquits the parallels with Robertson weremany but answered with an emphaticno because Buffett had not fallen into thetrap of buying companies trading at lowmultiples but with poor financials andweak future prospects. My argumentwas that Robertson appeared to have fall-en into the trap of buying companies ofincreasingly lower quality in order to con-tinue paying the prices to which he hadbecome accustomed.

To support my argument, I presentedthe table reproduced on this page, con-trasting the major U.S. public stock hold-ings of Buffetts Berkshire Hathaway andRobertsons Tiger Management. Everyone of Buffett's picks were characterizedby solid growth, high margins, great bal-ance sheets, and returns on equity thatexceeded their cost of capital. WhileTigers holdings were ostensibly muchcheaper, they also had lots of debt, lowmargins, poor returns on equity anderratic growth. My conclusion at thetime: This is a lame collection of compa-nies which deserves to trade at a lowaverage multiple!

As I prepared to interview Robertsonrecently (see page 21), I was curious to

Akre November 2006

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