OID: As one of our favorite contributors says, do any of these companies have names?
    Nygren: Absolutely. Tricon Global [YUM/NYSE] is a good example. We've paid between $25 and $32. So we don't have any meaningful profit in it.

OID: Staley Cates of Longleaf Partners talked about that one in our last edition.
    Nygren: I read that.

    [Editor's note: Besides Harris Associates and Southeastern Asset Mgm't (advisor to the Longleaf family of funds), also purchasing Tricon Global Restaurants during the third quarter according to Portfolio Reports was Berkshire Hathaway.]

OID: Might you tell us where you agree and disagree with him?
    Nygren: There was great overlap on how we think about Tricon. In particular, we like what they're doing in terms of refranchising their company-owned restaurants - selling them to franchisees and taking back a royalty fee from those units. And we agree with Staley that the resulting revenue stream is a higher quality income stream than the one that they get from owning the restaurants.

OID: Because, as he said, the resulting business earns higher returns - with little or no capital expenditures required to support those revenue streams.
    Nygren: Exactly. Plus, Tricon is able to sell off those restaurants at a substantial premium to the price at which their stock sells in the marketplace.

OID: And what do you judge to be the best yardstick to arrive at private market value in that business?
    Nygren: Well, if you look at the purchases that are taking place, EBITDA seems to be the number that they most frequently cluster around. When Tricon sells restaurants in the refranchising program, they typically receive 5-7 times EBITDA. And the stock today is trading at around 4-1/2 times our estimate of next year's EBITDA.
    Also, their income is more and more coming from this higher quality source which deserves a higher valuation than that of the restaurants they're selling.

OID: It's hard to argue with you there.
    Nygren: And we forecast earnings out two years. Then, based on the EBITDA or sales level or whatever measure it is that we think is best, we estimate a price that a buyer would pay two years from now. And then we discount that figure back to the present.
    In Tricon's case, using 12 times EBITDA on our estimate for 2002, we arrive at a private market value of between $65 and $70 at that time. And then we discount that figure back to the present using a 10% discount rate - which is the total of the current government bond rate plus a risk premium for Tricon of about 4%.

OID: That doesn't sound all that different from the $62 figure that Staley Cates came up with.
    Nygren: Because our approaches are pretty similar. Actually, Longleaf is probably the firm that approaches the investment decision-making process most similarly to us. And I say that without any hesitation.

    [Editor's note: Based on their most recent purchases, we'd have to agree. According to published reports, Southeastern Asset Management and Harris Associates had two purchases in common for the most recent quarter. Interestingly, according to the latest Portfolio Reports, Berkshire Hathaway also just happened to be buying those same two securities in the same period.]

OID: You said you look out two years. If you believe an industry may still be in disarray at that point, do you give a haircut to the multiple, the earnings or both?
    Nygren: The idea of looking out two years is that the opportunities we see are ones where we think the shortfalls are temporary or cyclical in nature. So we think that our two-year time horizon is long enough in most cases that we're looking out past the cyclical difficulty.
    But where we do think that two years isn't enough, we'll reflect that concern in our multiple.