ValueInvestor
February 28, 2006
The Leading Authority on Value Investing
Hating to Lose
To successfully buck the consensus you first have to fully understand what the
consensus is. That’s how Jon Jacobson and Highfields Capital excel.
A
fter a successful run trading options
on Wall Street, Jon Jacobson got his
first portfolio to manage at Harvard
University’s investment company in 1990.
“Back then you couldn't raise money with-
out a track record,” he says. “But they were
willing to give me $100 million to manage
the day I walked in the door.”
An excellent decision. When he left
Harvard in 1998 to start Highfields Capital,
Jacobson had turned that initial stake and
an added $200 million into $1.6 billion.
Since starting Highfields, which now man-
ages $8 billion, he and partner Richard
Grubman have earned a compounded
15.4% annually, vs. 4.4% for the S&P 500.
Valuation “dislocations” remain plenti-
ful, says Jacobson, who’s finding opportuni-
ty in Europe, energy and media. See page 2
Surgical Precision
Making smart subjective judgments first requires objective analysis of the infor-
mation at hand – a particular strength of Spencer Capital’s Ken Shubin Stein.
I NVE STOR I N S IG HT
Ken Shubin Stein
Spencer Capital Management
Investment Focus: Seeks companies for
which temporary events obscure near-term
prospects but do not materially affect long-
term earnings power.
INSIGHT
Inside this Issue
F E AT U R E S
Investor Insight: Jon Jacobson
Challenging conventional wisdom
I NVE STOR I N S IG HT on Penn West Energy, Saks Inc.,
Vinci and Lagardere. PAGE 1 »
Investor Insight: Ken Shubin Stein
Looking beyond the clouds at Foot
Locker, Tyco, Resource America and
Newkirk Realty Trust. PAGE 1 »
Uncovering Value: SuperInvestors
Recent superstar-investor trades show
that finding value in brand-name
stocks is catching on. PAGE 18 »
Behind the Numbers: Hedging II
Jon Jacobson Why a one-time short-selling star
Highfields Capital Management thinks the deck is overly stacked
Investment Focus: Seeks companies against the practice today. PAGE 20 »
trading at very low historical or competitive
valuations – for reasons that are both fully Of Sound Mind: Traits of the Great
understood and changeable. What truly sets the great investors
apart from the crowd? PAGE 22 »
Editors’ Letter
The battle lines are drawn over
shareholder activism. PAGE 23 »
INVESTMENT HIGHLIGHTS
A
fter several years pursuing in paral-
INVESTMENT SNAPSHOTS PAGE
lel his dual interests of medicine
Foot Locker 12
and investing, Ken Shubin Stein
Lagardere 8
hung up his stethoscope for good in 2000 to
Newkirk Realty 15
manage money full-time. “I enjoyed medi-
Penn West Energy 5
cine very much,” he says. “But I just
Resource America 14
enjoyed investing too much not to make a
Saks 6
career out of it.”
Tyco 13
Investors in Shubin Stein’s Spencer
Vinci 7
Capital Management have reaped the
rewards of that career decision. Since
Other companies in this issue:
November 2000, they’ve earned a net
Altria, Apollo Real Estate, Circuit City, CKE
24.1% compounded annually, vs. an annual
Restaurants, Comcast, ConocoPhillips,
2.1% loss for the S&P 500.
Corning, Covanta, Davita, DirecTV, General
Shubin Stein’s rigorous research process
Electric, International Coal, Knight-Ridder,
is unearthing many opportunities today,
McDonald’s, Microsoft, Morgan Stanley,
including those in big-name corporate
Pfizer, Reliant Energy, Time Warner,
underachievers as well as in companies he
Vornado Realty, Wal-Mart, Winthrop Realty
sees as potential hidden gems. See page 10
www.valueinvestorinsight.com

Coming Up Short
Short selling shares two key traits with the airline industry: New players keep coming into the
business … and net industry profits over time are below zero. By Joseph Feshbach
Editors’ Note: In our last issue (VII,
January 31, 2006), Whitney Tilson and
Glenn Tongue argued that bearish bets
through short sales and put options are
potentially viable money makers and a
sound way to hedge risk. This prompted
a response from Joseph Feshbach, who
sees short-selling as a loser’s game. Given
that Joe, along with brothers Kurt and
Matt, ran the largest short-only invest-
ment fund in the 1980s, we were eager to
hear this counter argument.
“Investing is most intelligent when it
is most businesslike,” wrote Benjamin
Graham, a sentiment that Warren
Buffett has described as containing
among the nine most important words
ever uttered about investing. Given that,
how would you judge an investing strat-
“I thought buying the boat would make him more
optimistic about the future but apparently not...”
February 28, 2006
B E H I N D T H E N U M B E R S : Hedging II
egy with the following fundamental eco-
nomic characteristics:
1) Limited potential returns, but
unlimited potential losses
2) Skyrocketing competition
3) Tax inefficiency
4) Aggregate net losses over its history
5) The elimination of a significant
source of income in recent years
6) Risk of asset repossession at
creditors’ whim
Having spent 15 years of my career
doing nothing but short selling – with
periods of great prosperity and other peri-
ods of fast, painful losses – I can argue
with some authority that, as an invest-
ment strategy, shorting suffers from each
of these characteristics of a bad business.
www.valueinvestorinsight.com
Nothing in my investing career has
been more satisfying than identifying and
profiting from the emperor-has-no-
clothes opportunities we repeatedly
found in the 1980s. But I’ve come to
believe that the game has become so
stacked against the short seller that it’s
just not worth the periodic emotional and
monetary high that comes from being
right with a bearish bet.
The business of shorting has only got-
ten tougher since my brothers and I left it
in the early 1990s. Rebates on the short
credit – a share of the interest earned on
the short-sale proceeds – used to be a sig-
nificant source of income for short sellers,
but have all but disappeared due to low
interest rates and even “negative rebates”
on hard-to-borrow stocks. There are now
a few thousand hedge funds looking at
the same short opportunities, versus a
few dozen 20 years ago. The tax ineffi-
ciency is more pronounced than ever:
short-sale profits are taxed at a short-
term capital-gains rate that is approxi-
mately 2.5 times the rate for long-term
gains. The landscape is littered with the
carcasses of short-only funds that never
made money, while long-term winners
are about as numerous as those in the air-
line industry.
Whitney Tilson and Glenn Tongue are
in good company with the poor perform-
ance of their bearish bets. According to
the investor presentation Carl Icahn used
in launching his activist hedge fund last
year, his returns from a mere 15 long
positions from 1996 to 2004 generated
$1.5 billion in profits. Conversely, his 24
short positions produced a comparatively
small $150 million in profits, 85% of
which came from a single position,
Conseco (a stock, by the way, that I
shorted about ten years too early!). Given
that this period included three years of a
gut-wrenching bear market, even Icahn
himself must be questioning the real ben-
efit of shorting.
Value Investor Insight 20

Whitney and Glenn offer a key argu-
ment for making bearish bets: hedging.
Specifically, they see such bets as “insur-
ance” against their portfolio of “80-cent
dollars,” and take comfort in the analogy
that “The fact our home didn’t burn
down doesn’t mean we’re upset that we
lost 100% of our ‘investment’ in home
insurance.”
But any insurance only makes sense at
a given cost, which I’d argue is too high
when it comes to short-selling. Great
short-sellers like Michael Steinhardt and
Edward “Rusty” Rose have made signifi-
cant profits over the course of their
careers from shorting, but from my inter-
actions with each, it was always clear that
their motives in shorting were not as
“insurance,” but as a vehicle to create
high absolute profits in every single posi-
tion, in up markets or down.
Are put options a better alternative
than shorting for making bearish bets?
They do take away the risk of unlimited
loss and aren’t susceptible to short
squeezes, but they suffer from two addi-
tional major flaws. First, other than dur-
ing the Internet bubble, I’ve found that
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February 28, 2006
B E H I N D T H E N U M B E R S : Hedging II
the most overvalued and hyped stocks are
small- or mid-caps, for which puts usual-
ly aren’t available or are extremely expen-
sive. Second, puts require that you be
right not only on the fundamentals, but
also on timing. Payday may arrive, but
your options may already have expired.
So if making bearish bets is the costly
game I think it is, how should value
investors address issues of risk manage-
ment, preservation of capital and periods
of underperformance? I like Icahn’s
description of his risk-management
approach as “fundamentally driven by
the underlying value of the company
rather than prevailing market condi-
tions.” In other words, nothing beats get-
ting the value proposition right on a
stock-by-stock basis as your best protec-
tion from permanent capital loss. I am
still looking for and finding 50-cent dol-
lars and would argue that the 80-cent dol-
lar offers both inadequate downside pro-
tection as well as insufficient upside
potential. I also insist on growth as a key
component of the investment thesis –
value accreting over time further
enhances the risk-reward equation.
Or call toll-free:
866-988-9060
www.valueinvestorinsight.com
Don’t worry about short-term swings
in performance. Contrary to modern
portfolio theory – and as legendary value
investors such as Buffett and Joel
Greenblatt have well articulated – portfo-
lio volatility and risk are not remotely
synonymous. Tweedy, Browne’s Chris
Browne studied the long-term perform-
ance of seven of the greatest value
investors in history and found that they
under-performed market averages
between 28% and 40% of the time –
sometimes accompanied by hair-raising
asset drawdowns – while still trouncing
the averages over long periods. My unso-
licited advice: Embrace volatility – you’ll
make more money in the long run.
There will, of course, be many market
swoons to come and short selling may
help mitigate losses during the toughest
times. But for my and my investors’
money, the structural disadvantages of
shorting make it too un-businesslike to
pursue. VII
Joe Feshbach runs Joe Feshbach Partners,
which invests primarily in companies facing
some type of crisis – from accounting scandals
to government investigations.
Value Investor Insight 21