Third Avenue Funds' Marty Whitman et al. (as featured in OID)

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from Outstanding Investor Digest's December 29, 1998 edition

THIRD AVENUE FUNDS'
MARTY WHITMAN ET AL.
(continued from preceding page)

GOOD TIMES IN THIS BUSINESS ARE VERY GOOD -
ESPECIALLY WITH SMART MANAGEMENT IN CHARGE.

    Whitman: One of the hardest things that we have to do is evaluate management. And since we began buying our semiconductor equipment companies, we've met - primarily one-on-one - with the managements of most of the companies we've bought. Nearly all of the ones that we've met are terrific - extremely dedicated and very good. We're very happy with 'em.
    In contrast, we have huge investments in Japan - mostly in non-life insurers, And I shouldn't say this...

OID: It won't go beyond our pages.
    Whitman: In one Japanese company after another, I feel as though I'm dealing with a bunch of deadheads. It's quite a contrast.
    But one after another, managers in the semiconductor equipment industry seem dedicated and smart - just the way we like 'em.

OID: Of course, that may be because those who aren't very nimble get winnowed out quickly in this business.
    Whitman: That's a good point.

OID: Explosive growth in demand sounds like a given. But there's been enormous growth in air travel, too. And the returns in that industry have been negative....
    Whitman: Prior to the current industry depression, the semiconductor equipment companies we're buying demonstrated substantial earning power relative to their capital employed and their current stock prices. In the good times, ROEs of 20-30% have probably been the norm.

OID: And during the bad times - like today, ROEs have no doubt been negative. But what kind of return do you think they're likely to earn over a full cycle?
    Whitman: Above average. But I can't refine it much.

    Jensen: Whatever the ROEs have been, it's somewhat misleading because so many of these companies have maintained relatively cash-rich balance sheets.

    Whitman: Again, these are very smart managers. Therefore, when things are going well, the stocks of these companies tend to get super P/E ratios in the stock market. And most of the companies that we own got their cash by taking advantage of super stock prices to issue stock. They've been terrific at that. When their stock's been up around 40 times earnings, they've often issued shares.

    Jensen: Exactly. For example, at the end of 1997, Speedfam did a secondary issue and raised money at $52 per share - or more than 3-1/2 times today's price.

    Whitman: And Lam Research did the same thing. They issued a subordinate convertible at $87 per share - or nearly 5 times its current price.

OID: Wow.
    Jensen: We also own the fixed-income securities of some super credits in the semiconductor equipment area. For example, we bought Cymen's 3-1 /2s of 2004 at a yield-to-maturity of about 17%. And their yield-to-maturity today is probably still 14-15% - which obviously isn't bad.

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