Dhandho!
Low Risk + High Uncertainty = High Rewards Mohnish Pabrai Managing Partner
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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
Nearly all successful startups step in to fill a gap – some arbitrage spread that exists. Eventually virtually all gaps close 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. As they scale this diminishes. As they compete with other Patels, its gone.
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Dhandho is Business Arbitrage 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 How much does it cost to start a trans-Atlantic airline with a Boeing 747? Airplane Cost, Reservation System, Advertising/Branding, Ground Staff, Crews … 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 The “mental business plan” was done in one weekend by 1 person with zero experience in airlines. No elevator pitch, no VCs, no board, no advisors. Capital-intensive business started with virtually no capital. Found a gap and saw a way to exploit it. Dhandho Arbitrage
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The Virgin Group 200 companies; 25,000 people; $7 Billion Revenue 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
The Patels and Branson:
Twins separated at birth?
Both took virtually no risk. However, they had tremendous uncertainty about the future.
The odds of getting a high return on their investment were very high.
No brainers!
This framework is a very powerful one for equity investors to use. www.pabraifunds.com
Low Risk + High Uncertainty = High Rewards Some stocks have a very murky future. Markets, even efficient markets, have a very hard time with these type of stocks. Canadian Oil Sands: What is the future price of oil? Covanta: Future electric rates and tipping fees? Silicon Valley Bank: What are those warrants worth? Frontline: What are future charter rates for tankers? Level 3 Bonds: Will they survive or go bankrupt?
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Pinnacle Airlines – Ultra Low Risk
Market Cap:
$190 Million (PNCL)
Excess Capital:
$90 Million ($4.09/share)
2006 Net Income:
> $2.25/shr. (9 Mos. = $1.87)
Net Stock Price:
$8.62 less $4.09 = $4.53
Net P/E Ratio:
2
Liquidation Value:
$210 Million ($9.55/share)
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Ultra High Uncertainty
Single Customer – Northwest Airlines
What will the new NWA contract look like?
EPS: From $2.50/share to $1.75? $1.50?
Use of Excess Capital?
Future Northwest Relationship?
New Pilots Contract – what will change?
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Ultra High Reward Potential
Symbiotic Relationship – Hard to severe.
Pinnacle is an extremely low-cost, efficient operator.
Next few years are like to be very good for US airlines.
Regional Jet Sales are likely to take-off.
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Pinnacle’s Pedigree
On the Magic Formula ($1/25 Search)
Highest Earnings Yield on the List (38%)
Pre-Tax Return on Capital > 100%
Write-up on Value Investor’s Club – 6.2 Rating
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
