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    Thursday, June 26, 2003

    Special situation investing was introduced to me by Joel Greenblatt in his book “You too can be a stock market genius”. This is an absolutely amazing book and fits incredibly well with my investing style. Joel also created a website called the value investors club, an exclusive online message board.

    I have been looking for spin-off opportunities since I first read the book. has been pretty helpful in identifying candidates. The reason that these opportunities are so exciting include:

    1. The spin-off of an S&P 500 company usually causes a large sell off of the spun-off company by S&P 500 index funds as the spin-off is usually not added to the index.
    2. The “parent” company of the spin-off has no incentive to advertise or talk up the spin-off. They have not engaged investment banks to sell the equity and therefore there is no market buzz or generally any advertising what so ever.
    3. The spun-off company is generally some kind of drag on the parent company’s valuation; that is the spun-off company isn’t very exciting and may not even be such a good company.
    4. Great documentation on the to-be-spun-off company is filed with the SEC in a form-10.

    All in all that means that in the beginning after the spin-off shares in the spun-off company are usually trading at a large discount. Joel gives lots of examples but one that I followed recently was Car Max (KMX). KMX was spun off from Circuit City on October 1st 2002 and I came across it when someone on one of the shows I watch recommended shorting it as Circuit City is in the S&P 500 and KMX would not be; a sound technical reason. I did some research and the fundamentals said KMX was an undervalued company so I didn’t short it. Bottom line, it’s up 100%!

    On June 30th Centex (CTX) is spinning off CAVCO (CVCO – soon to be). I did a lot of research on CVCO using the Form-10 filed with the SEC (see EDGAR). They had an independent valuation done of CAVCO and this values CVCO at .6x sales. They also mention that similar companies usually have multiples in the low teens. This would value CVCO at $21.3-$28.6 (based off earnings from continuing operations of $2.20 or sales of $35.59 per share). The valuation company did a discount cash flow analysis and looked at various operational and financial ratios to determine how the company should trade compared to their peers. Interestingly CTX has publicly stated that they expect the value of CVCO to be about $10 - $14 (see here). They are expecting around a 50% discount to Intrinsic Value as a result of the factors above.

    There are some concerns with CVCO and I don’t consider them to be a great company. They produce manufactured homes and have some retail outlets to sell them. The retail outlets are performing poorly and shutting them down has been a large drag on their reported earnings (including one time charges their income has always been negative). Once they stabilize the retail stores then they have a reasonable manufacturing business that won’t easily be subject to foreign competition (something I worry a lot about).

    Additionally the market is quite depressed right now for manufactured homes though CVCO has dealt with this by dramatically reducing costs. Any up tick in demand (probably commensurate with an improving economy) should have an accelerated effect on their earnings. Many providers of floor plan financing have exited the market or greatly reduced their lending by tightening their terms. As lenders start to forget the bad times and competition returns (as always happens in the economic cycle) financing for these homes will probably return to the old days.

    Of course, current case valuation is $21-$28 with no improvements in their market. If their profitability decreased by 5% per year with a 12% discount rate they would still be valued at $12.94. With a 5% growth rate and 12% discount rate they would be worth $31.38.

    I’m excited to see where this trades over the next few weeks and if this is below $10 I expect to take a large position.
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    Disclaimer and Disclosure Analyses are prepared from sources and data believed to be reliable, but no representation is made as to their accuracy or completeness. I am not paid by covered companies. Strategies or ideas are presented for informational purposes and should not be used as a basis for any financial decisions.
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