Bill Miller’s 2008 Letter Addresses Yahoo!, Countrywide
Bill Miller's numbers have been terrible, but he is not about to go into hiding. His latest letter is out, and he is not mincing words:
"This letter will be short and to the point: We had a bad 2007, which followed a bad 2006. Over this two-year span, we underperformed the S&P 500 by around 2000 basis points, our worst showing since the two-year period 1989 and 1990, where we underperformed by 2500 basis points."
"In the 25 years since we started the Value Trust in 1982, we have had six calendar years of underperformance. Despite that 19-6 record against the market, all the losses are painful. They are also unavoidable and unpredictable. It would be great if we could figure out how to never underperform. No one has been able to do that, but that does not make it any less painful."
He is making a case for equities, leaning heavily on historical valuations:
The valuation disparity between Treasuries and stocks is as great today in favor of stocks as it was in favor of Treasuries 20 years ago. Just prior to the Crash of 1987, stocks yielded about 2% (same as today), but traded at over 20x earnings. The 10-year Treasury yielded over 10%, vs. 3.6% today. The two-year Treasury now has a lower yield than the S&P 500, and that is before share repurchases, meaning you can get a greater yield in an index fund than you can in the two-year, and a free long-term call option on growth.
Bill must be a glutton for punishment, and continues to stick with his posture on financial stocks:
Even more compelling are financials, where you can get dividend yields about double that of Treasuries, which only adds to their allure, with them trading at price-to-book value ratios last seen at the last big bottom in financials.
He was far too early on this call, as evidenced by his performance. But he is apparently making a stink over the sale of Countrywide Financial (CFC-NYSE) to Bank of America, a stock he claimed last fall was worth $40 per share. The takeout price is not sitting well with him, apparently:
Legg Mason Capital Management (LMCM) is the largest shareholder of Countrywide Financial (CFC), holding about 11.8% of the company’s shares outstanding as of December 31, 2007. CFC is the nation’s largest mortgage originator and servicer. Early in January, CFC announced it had agreed to be acquired by Bank of America (BAC), with CFC shareholders receiving 0.1822 shares of BAC for each share of CFC. CFC shares traded over $40 per share a year ago. This offer values them at under $8… We were quite surprised by the decision to sell the company at close to a seven-year low in the stock price, and agreeing to a bid that amounts to only 30% of book value and under 3x consensus earnings for 2009.
What makes the decision puzzling is that the company was seeing solid deposit growth, has no apparent capital problems, was not forced by the regulators to seek a merger partner, and is in sufficiently sound condition to have declared its regular quarterly dividend at the end of January… We petitioned the Office of Thrift Supervision for permission to increase our holdings in CFC to up to 25% of the shares outstanding.
That permission was granted on January 18, and we (LMCM) have increased our holdings to about 86 mln shares, representing 14.9% of the company’s shares outstanding… We have asked CFC’s Board to eliminate the poison pill (or at the least provide us with an exemption from it) as it plainly is unnecessary since the company has already agreed to be acquired by BAC. Eliminating it would allow us to acquire additional shares, should we decide to do so… We will support the deal if we believe it is in the best interests of shareholders to sell to BAC, and we will vote against it if we believe greater value can be achieved by having CFC remain independent.
Miller is digging his heels in; apparently he does not want to move on from this losing position. He typically only turns over his portfolio 10% a year, and sticks with investments through thick and thin. He clearly think the deals timing was horrific, given the year-to-date rebounds in Countrywide’s peers:
Since the cut in rates, many companies closely tied to the housing and mortgage markets have seen their shares rise sharply. Washington Mutual, the nation’s largest thrift, is up over 30% this year. IndyMac, a smaller version of CFC, is likewise up over 30% this year. CFC shares, on the other hand, are down 25% as share price appreciation has been truncated by the deal with BAC.
Miller has many other comments, but his comments over the unfolding drama at Yahoo! will get the lions share of attention:
Subsequent to the deal being announced, we have met with Steve Ballmer, MSFT’s CEO, and spoken with Jerry Yang, CEO of YHOO.
YHOO’s Board has pledged to give the offer careful consideration and to do what they believe will deliver the most long-term value to YHOO owners. That is the right message, and we are waiting to hear their views as they develop. That said, we think it will be hard for YHOO to come up with alternatives that deliver more value than MSFT will ultimately be willing to pay.
We think this deal is a strategic imperative for MSFT, and that YHOO is in a tough spot if it wishes to remain independent. It has been reported that MSFT has been discussing a combination with YHOO for well over a year, and that it had been prepared to pay over $40 per share previously. We have no way of knowing whether those reports are accurate or not.
Our own valuation work puts the value of YHOO in the range of those reported numbers, though, and we think MSFT will need to enhance its offer if it wants to complete a deal. YHOO shares were recently trading at a four-year low, and the stock averaged above the current offer price for all of 2004.
YHOO is a uniquely valuable asset, and we expect MSFT will do what it takes to acquire it.
One last point: the 60% premium MSFT offered for YHOO highlights what we believe are the significant opportunities present in our portfolios. Clients and shareholders are understandably disappointed when the performance of their portfolio does not keep pace with the broader market. But the price of a publicly traded security is one thing, and its value is something else. Price is a function of short-term supply and demand characteristics, which are heavily influenced by the most recent news and results. Value is the present value of the future cash flows of the business, and that is what we focus on. We believe the values in the market today are as attractive as they have been in the past five years, and patient long-term investors (including the Fund) should be well rewarded for putting money to work right in here.
The market is a weighing machine in the long run, but a beauty contest in the short-term; and Miller’s numbers have been ugly. The courage of his convictions have been sorely tested, but he is sticking to his knitting. I do not agree with him on Countrywide, but consensus thinking is emerging that Yahoo! will get a sweetened offer. Is the worst over for Bill?
He is off to a slow start this year, but we do not expect a bottom quartile performance out of him in 2008.
Good luck, Bill.
Miller Letter
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The content contained represent the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.
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