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THIRD AVENUE FUNDS'
MARTY WHITMAN ET AL.
(continued from preceding page)
OID: Three against one, eh?! No problem - at least not as long as we get to do the final edit...
Whitman: Curtis Jensen is one of the co-managers of Third Avenue Small-Cap Fund. (I'm the other co-manager.) Prior to joining Third Avenue, he was a commercial banker and an outstanding student in the course I teach at the Yale School of Management.
And Yang Lie is Third Avenue's resident engineer and a very talented analyst. Prior to going back to school to earn her MBA, she was a project engineer at Motorola. And, frankly, I think both of them are better equipped to understand this business than either you or me.
OID: Why would semiconductor equipment stocks be compelling bargains at 65-85% of book value?
Whitman: Several reasons: First, as I said earlier, at year end 1974, the Dow Jones Industrial Average sold at 80% of book. Therefore, relative to book, these companies are literally selling at 1974-level valuations.
OID: You could say that about steel companies, too...
Whitman: And second, these aren't steel companies. Semiconductor equipment companies produce the equipment that semiconductor companies use in their "fabs" (short for "fabrication" plants) to produce their semiconductors (the industry jargon for which is "chips")
And I think that you begin to get a sense that these semiconductor equipment companies aren't such terrible businesses right away if you look back and see that compared to the last time these companies were reporting peak earnings - which was back around 1996 and 1997 - I think most of these companies saw their stock prices get up to 4-8 times book.
OID: Wow. Talk about a stark contrast in valuation...
Whitman: And it's worth noting that these firms tend to spend heavily on R&D and that all of their expenditures - 100% - are expensed. Not one penny of their R&D expenditures is capitalized - none. So, once again, there are virtually no intangibles on the books in this industry.
OID: That sounds like an extremely important point.
Whitman: You better believe it.
Yang Lie: Especially given the importance these companies tend to assign to keeping up technologically. Most of them have tended to spend 10-12% of their sales on R&D.
Curtis Jensen: So their earnings and book values are probably significantly understated. At the very least, they're conservatively stated.
OID: They sound very cheap.
Whitman: We think they remain fantastic bargains. And even though that segment of our portfolio is up a lot from its lows, nearly all of those companies remain on our buy list. Granted, these stocks are listed on the NASDAQ. Therefore, we can only buy 'em with limit orders - and our bids are below the market. But they are on our buy list.
Plus, the ones that I mentioned earlier aren't up nearly as much as that segment of our portfolio overall.
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