The Meeting 2 - Exhibit Hall

Aside from the meeting auditoriums where you get to listen to the Warren and Charlie show, there is also a big convention-type floor area with lots of exhibits from assorted Berkshire-associated companies. Here's some pics from when we walked around the floor after asking our questions. First, a couple pics of Nancy and myself with giant Berkshire company promotional figures. The Geico Gecko:
This also gives a good view of my full blinged-out meeting outfit. If you look closely at my chest, you can even see the small LED scrolling-message pendant, which I programmed stock ticker-style to keep repeating BRKA ... 40,000,000 ...
The Fruit of the Loom guys:
Unbelievably, as far as I saw they didn't have the best company mascot of all, the Geico Caveman! Here's some more pics from around the exhibit floor. A Geico custom bike:
A Geico racing boat:
A horrible painting of Buffett that some artist did before the meeting (with Benjamin Moore paints - a Berkshire subsidiary):
Nancy behind the wheel of a camper:
and myself relaxing on the bed of said camper:
And a great freebie they were handing out at the Mars/Wrigley booth - a bag of special edition M&M's with little pictures of Warren printed on (I really hope I can resist eating these ... )

The Meeting 1 - A Tale of Two Mungerisms

OK, on to the meeting report.

Note: because no audio or video recording is allowed during the meeting, all quotes are based on notes and possibly not verbatim.

For those unfamiliar with the Berkshire annual meeting format, a little background. It's held in a large arena called the Qwest Center in Omaha, and in recent years over 20,000 people have attended. The main attraction is the Q&A that Warren Buffett and Charlie Munger do from 9:30 to around 3. This is an amazing feat of public speaking - they take questions from the audience on any topic under the sun and, completely off the cuff, come up with informative and funny answers for hours on end. Most of the time, Warren will do most of the talking, and Charlie will come in with well-timed zingers. There's also a funny video they show at 8:30, and a large exhibit hall showing products from some of the many Berkshire-associated companies. Also, there are assorted parties at other venues through the weekend.

OK, enough background - now to our story. I had thought about asking a question at the meeting for a couple of years, and Nancy was interested in asking one for her book. Now, in theory anyone can ask a question - you just have to be first in line at one of the dozen or so designated mikes around the arena. But, considering there would be around 30,000 people there and Buffett normally gets to maybe 60 questions, I didn't have high hopes. (Foreshadowing alert) Little did we know that not only would we get to ask our questions, but we would each be the recipient of a vintage Charlie Munger zinger (thus the title of this piece)!

Luckily, we got together the night before the meeting with Mike and June Klein and a bunch of other people from the Motley Fool boards. I was talking to Mike about asking a question, and he mentioned that though he had never wanted to, someone he knew had said that the mike in the overflow room was a good place to go for that (this is a side room with video feed that people can go to when the main arena fills up).

So, the next day we arrived at the Qwest Center a minute or so before the doors opened at 7 AM to find a mass of humanity:
We walked by the mass to the main entrance area, and despaired of getting in quickly due to the huge line snaking all over. However, within a couple of minutes after the doors opened the social contract broke down entirely and people just started going right for the doors. We joined the mob - here's the mass of humanity inside shorty afterward:
They later announced the crowd in attendance this year at around 31,000. Now, my initial plan had been to go to the main arena and try and find a mike up in a corner somewhere where the line to ask questions might be shorter. But, we remembered what Mike said about the overflow room. We had no idea where that room was, but, shortly after we went up that escalator, I saw it appear like a mirage on our left. We cut away from the crowd charging for the main arena, walked right into the huge, completely deserted overflow room, and promptly signed ourselves up as number 1 and 2 on the list for that mike. This was shortly after 7:00. Considering the Q&A was going to start at 9:30, and our mike was the last in the rotation, this barely gave us 3 or 4 hours to schmooze with Mike and June, finalize our questions, and rehearse asking them. It was tight but we just made it.

Nancy went first, asking Buffett what advice he would give introverts to help them raise their visibility in their careers. Buffett lit up like a Christmas tree! You could tell this was something close to his heart. He began by saying, amazingly, that he used to be terrified of public speaking - even the thought of it was enough to make him physically ill. He told a funny story about signing up for a Dale Carnegie course for $100 in New York, then going home and stopping payment on the check ("you're looking at a real man of courage here!"). He said that the ability to communicate, both in writing and orally, is enormously important and undertaught. And, he told Nancy that she was doing something very worthwhile if she was able to help introverts get outside of themselves (at this point I must admit I was starting to seethe with jealousy!)

And, just to add the cherry on the sundae, Munger chimed in:
"It is a pleasure to have an educator come who is doing something simple and important rather than foolish and unimportant!"

I went next, around an hour later. I knew that both Buffett and Munger had on some occasions made really big bets, putting 25% or more of the bankroll into one position. I asked for some examples like this and what their thinking was at the time - while I'm not confident enough to make such large bets myself, I figured it would at least be instructive to go back over some examples where Buffett and Munger were. Buffett wasn't as delighted with my question as he was with NANCY'S (mutter mutter), but I found their answer interesting. First, they did give some particular examples, including Cap Cities and Coca Cola back when they originally bought (I believe in the 70's and 80's), and junk bonds in 2002. They also proved to be even more extreme about concentrating than I thought - Buffett said there were quite a few occasions he could think of when he would have been comfortable putting 75% in one position, and Munger talked about over 100% (as Buffett noted, this might require a friendly banker). Interesting for me to hear since my hands start shaking at around 10%! And, I personally would advise you not to try it at home - to use John Train's metaphor, this is like swinging a tennis racket as hard as you can - works if you're Andre Agassi, but likely to result in a lost ball otherwise.

And then Charlie topped it off with a good food-for-thought zinger, going something like: "Conventional investment theory sees safety in diversification. This is exactly bass-ackwards. The whole point of investing is to find things where it's safe NOT to diversify."

Kind of high off the experience but reeling a bit, we staggered back to Mike's block of seats and rested for a while before going to the exhibit hall. More on that later ...

Isaac

Dateline ... Omaha!

OK, as some of you know my girlfriend and I have made a pilgrimage to Omaha to bask in Warren Buffet's warm, calming glow. Of course, last weekend was way too busy to write anything since it was Berkshire Annual Meeting time, so I'm going to try and catch up this week.

First, we're staying in this cool happening loft building right in the heart of Omaha's cool happening Old Market neighborhood:

I guess this district is roughly the Omaha equivalent of Soho or the meatpacking district, although parking is a little cheaper:

The neighborhood is pretty interesting - very artsy, lots of galleries, cafes, lounges, and antique/collectible shops. I'll try and post more neighborhood photos later, but first some pics from our building. Our kitchen:
Note complimentary food basket on the counter! Our living room:
It's hard to tell from the photo, but the ceiling is like 20 feet high! And last but not least, our panoramic balcony view:
Oh well, at least we have a balcony ...

Here are some of the views from the roof of the building. Harrah's casino across the river in swinging Council Bluffs, Iowa:
The famous Woodmen tower - as seen in the opening of About Schmidt:
More of the Old Market area:

And there are some cool places right downstairs in our building - a nice coffee place with huge cinnamon rolls for $1.75:
which had a beautiful Weimeraner sitting in front the first day:
A very trendy looking wine bar:
And a trendy-looking lounge that I don't have a good picture of.

The building also has some cool features - a nice gym with view:
A nice atrium:
Plus the elevators have this really cool pattern engraved into the metal that looks very three-dimensional if you stare at it:

Well, that's all for now - I'll try and get to the meeting report next time ...

Here's another investment idea that I originally posted on the Motley Fool on Aug. 8 - Span-America Medical Systems (SPAN).

Caveats: This one is too small for some of you - it currently has a market cap under $50M, though it does have average volume of close to $1M a day traded. This isn't a buy recommendation - do your own due diligence!

I think I remember Peter Lynch saying something like he'd rather buy a 30% grower at 30x earnings than a 10% grower at 10x earnings. On the other hand, how about a 30% grower at 10x earnings? And in a pretty recession-resistant business with decent secular growth prospects to boot?

The business: mainly medical foam rubber products and accessories (why am I reminded of Hank Hill's propane and propane accessories?). It occurs to me that the demand for these is unlikely to be much affected by the ability of John Q. Hedgefund to float subprime paper. Also that long-range demand looks pretty good thanks to the graying and subsequent groaning of America.

Operating income for the last three fiscal years ending 9/30/2006,05,04: $4.0M, $3.1M, $2.3M

Operating income for the subsequent three quarters, YOY gain:
6/30/2007: $1.8M, +77%
3/31/2007: $1.7M, +123%
12/30/2006: $1.5M, +40%

Over the past couple of months I've noticed some exceedingly weird stock price movements in many individual stocks, and this is one prime example. The stock price rallied strongly starting in April, probably because they announced a special $5/share dividend. It then became quite choppy for the next few months - I suspect this is because it made it onto one of the IBD mo-mo screens. It hit a high of almost 31 on July 9. Subsequently, on no news other than the blowout earnings report released on July 24 (this is the 6/30/2007 line above), it has had a modest haircut of roughly 50% to the current level of 16 and change. While there certainly may be more short-term pain in store, this does seem to me like it might be a decent price to pay for a share of the business.

Isaac

Greetings, everyone - here's a writeup of one of my favorite ideas at the moment, Dreamworks Animation (DWA).

The business: animated family movies

Dreamworks Animation (DWA) produces animated family movies in the relatively high-budget, aiming-for-blockbuster category. They were originally the animation division of Dreamworks SKG, which was formed in 1997 by Steven Spielberg, Jeffrey Katzenberg, and David Geffen. DWA is now an independent company, spun off from Dreamworks SKG in 2004, with Katzenberg at the helm. Before Dreamworks, Katzenberg was head of the movie division at Disney from 1984 to 1994.

DWA has in the past produced movies using three types of animation: CGI (computer animated using solid models, ex. Shrek), traditionally drawn (ex. Prince of Egypt), and stop-motion or claymation (i.e. Wallace and Gromit). Currently and going forward they are exclusively producing CGI animated movies.

Does DWA have a moat (durable competitive advantage)?

I believe one of the most reliable ways of checking for a moat is to look back in time and see how competitors have fared over the years. If you see the same names on top year after year, it's a good bet there is some sort of moat operating there. In DWA's field of CGI-animated films, the history available is not that long - I believe the first CGI animated feature film was Toy Story, produced by Pixar in 1995. However, I think it's long enough to be significant, considering that there have been many attempts by other companies to enter the field due to the rich rewards for success. Let's take a look at the all-time top ten CGI-animated films in terms of worldwide box office (note - the source for most of the box office information in this writeup is the excellent website www.boxofficemojo.com):
Shrek 2 (DWA, 2004) $920.7M
Finding Nemo (Pixar, 2003) $864.6M
Ice Age: The Meltdown (Fox, 2006) $651.6M
The Incredibles (Pixar, 2004) $631.4M
Shrek the Third (DWA, 2007) $574.9M - note this is still running in many foreign markets and will probably wind up around $800M
Madagascar (DWA, 2005) $532.7M
Monsters, Inc. (Pixar, 2001) $525.4M
Toy Story 2 (Pixar, 1999) $485.0M
Shrek (DWA, 2001) $484.4M
Cars (Pixar, 2006) $462.0M
In other words, in spite of many well-financed attempts by other major film production companies, only one of the top 10 CGI films of all time has been produced by a company other than Pixar and DWA. So, in order to be successful in this field there is clearly some required combination of management, talent, and distribution that is difficult to duplicate. Another interesting bit of trivia - if we include traditionally drawn animation, there are two films that would crack the top-10 list above: The Lion King and Aladdin. Is it entirely coincidental that both of these were produced at Disney under Katzenberg?

As another check, we can look at the record of DWA's movies in particular. At first glance, it appears a bit mixed. However, I think we have to separate a few things out. As mentioned above, DWA in the past produced several traditionally-drawn and stop-motion movies, and these have had mixed results. This is probably a result of the surprising fact that audiences in general have really fallen for CGI animation and are no longer willing to go to traditionally animated movies regardless of quality; in fact, no one has produced a megahit using traditional animation since The Lion King in 1994 (or, charitably, Tarzan in 1999).

If we look at just the CGI films that DWA has produced, the record is much more consistent. Of the eight such films DWA has produced since 1998, there are two megahits (Shrek 2 and Shrek the Third), two big hits (Madagascar and Shrek), two moderate hits (Shark Tale and Over the Hedge), and two disappointments (Antz and Flushed Away - note even these made over $170M each). Even in the case of the two disappointments, there are some extenuating circumstances - Antz was their first CGI movie, and Flushed Away was made for them by Aardman Studios, a British stop-motion studio with which they are no longer associated. In sum, DWA's record in their current business of CGI movies is remarkably consistent for a field that is so unpredictable in general.

Is DWA Cheap?

DWA is currently trading at a market cap of around $3B, and has around $500M in cash on the balance sheet. Thus the business is valued by the market at around $2.5B. Does DWA have the earnings power to support that value?

At first glance, the answer may appear to be no; DWA had minimal earnings in the past year. This, however, is deceptive. DWA is a classic case of what Buffett calls lumpy earnings - they earn a lot in periods where megahits are released, and much less in periods with box office disappointments. Let's try a few different approaches to estimating how reasonable DWA's valuation is. In the spirit of Buffett's saying that it's better to be roughly right than precisely wrong, these will be back of the envelope rather than 20-year discounted cash flow analyses.

As a first hack, let's smooth DWA's earnings over the past three years (2004-2006). I believe this is reasonably conservative since this period contains one megahit (Shrek 2), one big hit (Madagascar), two moderate hits (Shark Tale and Over the Hedge), and two disappointments (Wallace and Gromit and Flushed Away). The last two were made for DWA by Aardman, which as mentioned above is a British stop-motion studio with which DWA is no longer associated. DWA will now make all its own movies using CGI animation, so based on their CGI track record above I believe the results of their next three years are likely to be better. However, even taking the past three year's earnings, we get a total of around $450M, or around $150M a year - giving a reasonable adjusted price/earnings of 16 or 17.

Coming at it from another angle, we might note that DWA can reasonably expect to come out with a sequel to its megahit Shrek franchise every three years. Judging by the success of Shrek the Third, this franchise seems to be so well established that as long as the sequels meet minimal quality standards they should do $700M-800M in worldwide box office (as I argue below, this number should actually go up over time). Considering the additional high-margin revenue from DVD sales and licensing, I think you could make a reasonable argument that the value of the Shrek franchise alone is not that far from what DWA as a whole is selling for, so you're paying very little for an option on all their other movies and characters.

As one more check, let's look at buyout transactions of comparable companies. Unfortunately there's only one I can think of, the Disney buyout of Pixar in 2006. Disney paid a rather eye-opening $7.4B in stock to acquire Pixar. This discrepancy with DWA's current market cap naturally leads to two questions:
1) Was Disney nuts, i.e. did they wildly overpay for Pixar?
2) Was Pixar worth a lot more than DWA?
These are impossible to answer precisely, but in my opinion the answer to 1) would be that Disney was not nuts, and if there was some overpayment it was mild, not wild. My answer to 2) would be that one could reasonably argue Pixar was worth more than DWA or vice versa, but in any case the difference is not large.

And a few hidden kickers

The previous section argued that DWA's is probably selling at a reasonable valuation. But for me, what promotes DWA from good-company-at-fair-price to trembling-with-greed territory are a few hidden kickers not reflected in the above valuation discussion. These extras are hard to quantify, but I think each is significant and together they give a very nice bump to DWA's ultimate value:

Rapid growth of a middle class in developing countries, both in the BRIC countries and elsewhere. This middle class may still be too poor to afford many SUV's or Mcmansions, but they sure can afford treating the family to a movie. This effect is already quite visible. For example, here are the grosses for the Shrek series in Brazil:
Shrek (6/22/01): $4,565,267; Shrek 2 (6/18/04): $9,457,271; Shrek 3 (6/15/07): $14,325,005 after 17 days
and in Russia:
Shrek (11/2/01): $1,070,302; Shrek 2 (8/19/04): $5,647,027; Shrek 3 (5/17/07): $22,797,727 after 7 weeks

Development of new formats and outlets over time, for example hidef DVD, 3D movie exhibition, TV on cellphones/iPods. DWA can with minimal effort and cost re-release its old movies on these formats. Or, in other words, same sh*t ... mo' money! Also, DWA owns the rights to its characters and so can license them for even newer-fangled outlets that may come along such as new game systems or Web virtual worlds.

Wonderful economics of a successful family movie franchise - this is somewhat related to the previous point. DWA ultimately plans to release two movies a year, one of which will be a sequel in a franchise such as Shrek or Madagascar. These sequels have some delightful properties. For one thing, they allow for re-release of earlier episodes on whatever newfangled home format is current. For another, the typical three year interval between sequels is great for increasing the fan base for family movies: older kids want to see the sequel to see what happens to the characters they loved, and younger kids want to be included in whatever their older siblings are doing.

Deflation in the cost of computer processing over time. This is a major expense for DWA, and the availability of cheaper computing power over time will enable DWA to either increase their animation quality or reduce production costs.

Defensive quality of cheap entertainment: spending on this tends to hold up even in hard economic times. My favorite example is Gone With the Wind. This movie is almost four hours long, and was released at the tail end of the Great Depression (1939) at a time when the U.S. population was less than half the current 300M. Yet it still is the all-time U.S. box office champion in inflation adjusted terms.

World trade rebalancing - if you believe that the current mammoth U.S. trade deficit will explode into a financial catastrophe the likes of which the world had never seen, you can skip this point. If, however, you think trade will over time come back closer toward balancing, it strikes me that this might happen in part by having the big trade surplus countries enable their citizens to spend more on goods produced in the U.S. (as I said above, this effect is already visible to some extent). I think cheap entertainment is a good candidate for some of this spending.