The Rude Awakening
Wall Street, New York
Tuesday, January 17, 2006 ------------------------- - The opportunities that arise when Wall Street and
Main Street disagree,
- Buying assets in the stock market that are selling
for deep discounts to their real-world values and,
- An email exchange that sees France and America on the
verge of an epic battle…of wits.
------------------------- Eric Fry, reporting from Baltimore, Maryland… "For the sake of lending moral support to your difficult
day," began a recent email from a French friend, "I
searched my mind for the most idiotic quotation that I
could recall. The result is this: 'Money is like a woman.
To hang onto it, you must treat it with good sense and
prudence. If not, it will find the kindness of another.'
"I wish you a day filled with good sense and prudence. And
remember, even in the worst of circumstances, bad luck
always produces more virtue than good luck." "Wow!" your editor replied. "What a font of wisdom and
common sense you are! As I was pondering the insight you
sent me about caring for money, I just could not escape the
sensation that this insight contained a second, hidden
meaning. Perhaps this second insight will manifest itself
if I read the email several more times. "In any event, please allow me to return insight for
insight. First, about money, a British priest once
observed: 'Poverty is no disgrace, but it is confoundedly
inconvenient.' And whenever other forms of 'inconvenience'
or bad luck arrive, we should always remember the words of
William Shakespeare: 'Sweet are the uses of adversity,
which like the toad, ugly and venomous, wears yet a
precious jewel in his head.' "Or if you prefer, embrace the perspective of Oscar Wilde
when he remarked, 'We are all in the gutter, but some of us
are looking at the stars.'" "I refuse to engage in a battle of wits," the French friend
continued. "But I have decided nevertheless to send you my
thought of the day. It is from Jean-Claude Van Damme. I'm
sure you know him as the rugged action-film star. But in
France, he is famous for being stupidity incarnate.
"Back in the days when I was laboring over my doctoral
thesis, a friend of mine would routinely add a little
levity to my day by sending me quotations from Van Damme.
Here's one of my favorites…(The quote works best if you
remember that Van Damme is utterly humorless and intends no
irony whatsoever): 'I adore peanuts. You drink a beer and
you are craving something to go with it. So you eat
peanuts. Peanuts are sweet and salty, strong and tender,
like a woman. Eating peanuts…It's really a strong
feeling. And afterwards, you become thirsty for a beer
again. Peanuts and beer typify the cycles of human
experience.'" To which your editor replied: "I did not know that Jean-
Claude Van Damme was also an actor. I have always thought
of him as only a philosopher. I must see one of his films
one day. I appreciate the profound similarity he perceives
between women and peanuts, but I think that women are much
more like beer: bubbly and intoxicating. If I were to
continue the metaphor, I might also imagine that excess
consumption produces headaches…But I am not the
philosopher. That role belongs to Mr. Van Damme. "This email exchange has been a profound benefit to us
both, I am sure. You have learned something about caring
for your money, and I have learned a little something about
caring for my peanuts…" As it happens, dear investor, Chris Mayer, the editor of
Capital and Crisis, also knows a thing or two about caring
for peanuts, provided that beer and playing cards and poker
chips are close at hand. But Chris also knows quite a bit
about caring for money. As a former banker, Chris learned
to become the sort of investor who measures twice and cuts
once…literally. He measures the public market values of specific stocks
against their private market values. And whenever the
spread between the two becomes enticingly large, he takes
action…as he explains below.
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Written by Chris Mayer
Edited by Eric Fry Wall Street and Main Street rarely agree about the price of
anything. Sometimes Wall Street values certain assets above
what private investors would pay. At other times, Wall
Street prices out-of-favor assets well below what private
investors would pay. The latter of these two pricing
disparities is the sort of thing that causes us value
investors to bound out of bed in the morning. Whenever we discover assets in the stock market that are
selling for deep discounts to their real-world values, we
have usually discovered a compelling investment
opportunity…just like I did in October of 2004. Back
then, the stock market was assigning an insultingly low
valuation to the shares of Orient-Express (NYSE:OEH), an
owner and operator of luxury hotels, restaurants and
tourist trains. By buying OEH stock you were paying far less for comparable
hotel assets than what private market buyers were paying
for similar properties. Not only that, but hotel properties
of all types had been commanding ever-higher prices in 2003
and 2004. The average price per room for luxury hotels in
2004 was about $140,000 and climbing. 
Super luxury hotels of the sort that Orient-Express owns
were commanding a multiple of that price. Orient's Hotel
Cipriani in Venice, for instance, is one of the world's
finest hotels - fitted with precious marble and stucco.
Room rates are as high as $5,000 per night and industry
experts estimated that the 103-room hotel was worth at
least $1 million per room. That's just one asset in OEH's
portfolio.
In looking at transactions for super luxury hotels, you
could get a better sense of this market. The Four Seasons
in Maui sold for an estimated $740,000 per room in 2004,
for example. Yet the stock market was valuing Orient-
Express at only $226,000 per room - not including the value
of its interests in three fine restaurants and luxury
trains. So I recommended the stock to my subscribers. Today, after
more than doubling in price over the last 18 months,
Orient-Express shares are no longer cheap. In fact, that
loook quite pricey indeed, which is why I urged my Capital
& Crisis subscribers to book their profits and await the
next opportunity. Orient-Express now trades at an Enterprise Value (market
cap, plus debt, less cash) to EBITDA ratio of nearly 25
times. This value is nearly double what control investors
have recently paid for hotel assets. For example, Hilton
Hotels Corp. recently agreed to purchase the hotels of its
European namesake for about 12 times estimated 2006 EBITDA.
And many people think that was high. I realize they are not
truly comparable properties. Nonetheless, the gap is huge. This kind of analysis - taking a look at private
transactions and the prices control investors are paying -
is extremely useful for figuring out what's cheap and
what's not. Most investors only consider comparing publicly
traded companies to other publicly traded companies -
entirely neglecting this important "second" market for
stocks, where prices are determined by well informed buyers
and sellers. So what stock market assets are cheap today, based on
private market values? One candidate would be timber. Peter Langerman, who runs
the respected value-fund Mutual Series, likes timber
assets. Private buyers, he notes, are paying between 16 and
20 times cash flow for timber properties. Yet, the stock
market values most timber stocks at only around 8x cash
flow. Langerman likes Potlatch, Weyerhauser and International
Paper. In Capital & Crisis, we hold Plum Creek Timer (NYSE:
PCL), a timber REIT. It's another variation on the same
idea and given the favorable tax status of the REIT
structure, Plum Creek deserves an even higher multiple than
timber assets held by more heavily taxed operating
companies. Another interesting example of the private-public market
arbitrage involves Intrawest (NYSE: IDR), the owner and
operator of ski resorts, including the highly prized
Whistler Mountain operation. I recommended the stock in
April when it was trading at an EV/EBITDA multiple of only
6x. So far, the stock is up 45% since our recommendation.
But we think IDR is still undervalued. Its EV/EBITDA multiple is only around 9. The private market
is swapping comparable properties for 11X and greater. For
example, Intrawest sold its majority interest in the
Mammoth Ski Resort to Starwood Capital for 11x EBITDA. I'll leave you with one other example, though it's bound to
be unpopular. I recommended NewAlliance Bancshares
(NAL:nyse), a Connecticut-based thrift in my letter Capital
& Crisis. Banks, and thrifts especially, are not
particularly popular right now. The price to tangible book ratio - a commonly cited ratio
when dealing with financial institutions - is only about
1.8 times today for NewAlliance. If you compile a list of recent transactions for thrifts
and banks, you'll see the acquisition multiple paid is
closer to 3x tangible book. Here is a table, courtesy of
SNL Financial, that shows the top deals in 2005, limited to
only those banks in the New England and Mid-Atlantic
regions:
 Source: SNL Financial (www.snl.com) The table is limited to deals of at least $100 million.
Smaller transactions get smaller multiples. But even if you
include all of them, the average price to tangible book
ratio paid is about 2.5 times. NewAlliance is a substantial bank, the fifth-largest in
Connecticut, which is a desirable and affluent market. Even
if you only use the 2.5 times tangible book, you get a
price of around $20 or $21. That's nearly 40% higher than
today's $14.51 stock price. The bank is over-capitalized, which is one reason it has
been buying back its stock and boosting its dividend.
Nonetheless, it remains a prime takeover target. All the stocks I've mentioned provide an opportunity to
profit from the pricing disparities between public market
values and private-transaction values. So whenever you're
trying to buy stocks cheap, you can't afford to ignore
what's happening in the private markets. Net-net, whenever Wall Street and Main Street disagree,
opportunities emerge. [Joel's Note: One thing there is no disagreeing about is
Chris Mayer's ability to deliver solid opportunities to his
loyal reader base. He has done so time and time again,
highlighting but a few examples above. If you are looking
for flashy, million-dollars by tomorrow kinds of services,
Chris is not your guy. He tends more towards the slow burn
with longer-term plays and steadier, more reliable profits.
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long-term winner. The Only Company You'll Need - For 10 Years
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http://www.agora-inc.com/reports/MST/EMSTFC00 ------------------------- [Joel's End Note: A slightly leaner Rude for you this
morning (sans market data) as we are en route to Central
America to bring you news of investment opportunity from
the magnificent land of Nicaragua. Feel free take this time
to pen us your thoughts on the article above or any that
you find in our archives on the www.the-rude-awakening.com
website. Let us know subjects you would like to see our
intrepid editors tackle next or suggestions on how we can
improve your Rude reading experience. Send all massive
missives and curious contemplations to:
aussiejoel@the-rude-awakening.com Cheers,
jOEL | 
