dhandho vic nyc 2006 - ValueWalk

Not only are Dhandho entrepreneurs not risk takers, they are arbitrage players. 3 0 M i l e s ... Write-up on Value Investor’s Club – 6.2 Rating...

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Dhandho!

Low Risk + High Uncertainty = High Rewards Mohnish Pabrai Managing Partner

www.pabraifunds.com

Defining Dhandho Mr. B. U. Patel – Founder/CEO of Newport Beach, CA based Tarsadia Hotels – Probably the richest South Asian in Southern California. • From a 20-room Anaheim, CA motel to 4400 rooms - a 28-year Dhandho journey. •

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The Patel-Motel Dhandho Model Refugees from East Africa – Strong entrepreneurial drive with nothing to lose. • Buy a small single model with the family living in and working all the facets of the motel. • Highly leveraged. No downside. • Maximize cash flow and reinvest in another motel. •

Heads - I win! Tails - I don’t lose much! www.pabraifunds.com

The Patel-Motel Dhandho Model The Patel-Motel ends up being the lowest priced provider due to an intense focus on operating costs. • Porter would call this “Sustainable Competitive Advantage” and make it a book. • Buffett would call it a “Moat” • Mr. Patel would scratch his head and say … Dhandho? •

• 1/3 of all motels in the US are Patel Owned. • Over 20,000 motels – Over $40 Billion in Value. www.pabraifunds.com

Enduring Arbitrage Spreads Œ Œ Œ

Nearly all successful startups step in to fill a gap – some arbitrage spread that exists. Eventually virtually all gaps close Œ Some can close in a few months and others can persist for decades. The Patel-Motel Arb is low cost producer and hence low cost provider. Œ As they scale this diminishes. Œ As they compete with other Patels, its gone.

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Dhandho is Business Arbitrage Œ Not only are Dhandho entrepreneurs not risk takers, they are arbitrage players.

Town A Pop: 40,000

Heads I Win; Tails I Don’t Lose Much

• Start with 1-2 Chairs. • Charge a bit more. • Expand as business grows • Upside: Good; Downside: Minimal • Eventually premium disappears.

30 M iles

Town B Pop: 30,000

Emerging Town C Pop: 200 to 1000

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The Birth of Virgin Atlantic Œ How much does it cost to start a trans-Atlantic airline with a Boeing 747? Œ Airplane Cost, Reservation System, Advertising/Branding, Ground Staff, Crews … Œ Virgin started with no written business plan and total outlay of under $500,000. Maximum loss with total failure was under $3 Million.

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Virgin Atlantic Dhandho Œ The “mental business plan” was done in one weekend by 1 person with zero experience in airlines. Œ No elevator pitch, no VCs, no board, no advisors. Œ Capital-intensive business started with virtually no capital. Œ Found a gap and saw a way to exploit it. Œ Dhandho Arbitrage

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The Virgin Group Œ 200 companies; 25,000 people; $7 Billion Revenue Œ Common theme for all businesses – virtually no capital to start-up. Classic Dhandho. The VC model of the future. All start with Dhandho arbitrage and brand.

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Low Risk + High Uncertainty = High Rewards Œ

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The Patels and Branson: Œ

Twins separated at birth?

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Both took virtually no risk. However, they had tremendous uncertainty about the future.

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The odds of getting a high return on their investment were very high.

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No brainers!

This framework is a very powerful one for equity investors to use. www.pabraifunds.com

Low Risk + High Uncertainty = High Rewards Œ Some stocks have a very murky future. Œ Markets, even efficient markets, have a very hard time with these type of stocks. Œ Canadian Oil Sands: What is the future price of oil? Œ Covanta: Future electric rates and tipping fees? Œ Silicon Valley Bank: What are those warrants worth? Œ Frontline: What are future charter rates for tankers? Œ Level 3 Bonds: Will they survive or go bankrupt?

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Pinnacle Airlines – Ultra Low Risk Œ

Market Cap:

$190 Million (PNCL)

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Excess Capital:

$90 Million ($4.09/share)

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2006 Net Income:

> $2.25/shr. (9 Mos. = $1.87)

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Net Stock Price:

$8.62 less $4.09 = $4.53

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Net P/E Ratio:

2

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Liquidation Value:

$210 Million ($9.55/share)

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Ultra High Uncertainty Œ

Single Customer – Northwest Airlines

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What will the new NWA contract look like?

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EPS: From $2.50/share to $1.75? $1.50?

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Use of Excess Capital?

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Future Northwest Relationship?

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New Pilots Contract – what will change?

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Ultra High Reward Potential Œ

Symbiotic Relationship – Hard to severe.

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Pinnacle is an extremely low-cost, efficient operator.

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Next few years are like to be very good for US airlines.

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Regional Jet Sales are likely to take-off.

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Pinnacle’s Pedigree Œ

On the Magic Formula ($1/25 Search)

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Highest Earnings Yield on the List (38%)

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Pre-Tax Return on Capital > 100%

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Write-up on Value Investor’s Club – 6.2 Rating Œ

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Only 3 stocks (out of hundreds) have a rating above 6.2 in last 6 months!

Disclaimer: Do your own independent research! www.pabraifunds.com

Publisher: John Wiley

April 6, 2007 Pre-order your copy on Amazon today! Thank you! www.pabraifunds.com

Thank You. Mohnish Pabrai Managing Partner Pabrai Investment Funds Irvine, California, USA [email protected] Tel. +1949.275.5652 www.pabraifunds.com www.pabraifunds.com