A Bargain Hunter Stands Tall

KIPLINGER'S: What were you doing as the markets gyrated so dramatically in the fall?

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BERKOWITZ: Although the fall in stock prices hurt our performance, it has been a blessing. We've been buying companies at prices that even when I was in my most pessimistic mood, I didn't think we would see so quickly. These are 1974-type valuations, and what's fascinating is that stocks fell to these levels not because of earnings issues but because of the sheer magnitude of the forced liquidations. So this is still a bargain hunter's dream.

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We are selling that which is cheap to buy that which is cheaper, in order to make more money in the future and to help manage taxes for our shareholders. And we're pairing our stock positions with senior subordinated debt.

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So you're buying the bonds of companies whose stock you own?

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Yes. Some of the stocks we hold are so cheap that we fear the companies will be taken over at too cheap a price. So we're buying discounted bonds that have anti-takeover triggers, meaning the price of the bonds will immediately rise to 100 cents on the dollar on a change of control. And if we like the stock, we don't mind owning bonds that are yielding 15%, 16%, 17%.

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What's the worst that could happen to Sears, one of your biggest holdings?

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It gets slowly liquidated, or Eddie Lampert, its chairman, takes the company private. But I don't think he'd do that to shareholders.

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We didn't buy Sears based on the business. There's too much retail in the U.S. If the retail works, then it's a grand slam home run. We invested because of the company's real estate holdings. It has some fabulous locations -- a Kmart in Bridgehampton, N.Y., and a Sears on PGA Boulevard in West Palm Beach, Fla., for instance. The real estate alone is conservatively -- and I mean conservatively -- worth $90 per share [the stock traded at $53 in mid November].

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Are your health-insurance and drug stocks examples of your contrarian bent?

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We bought Wellcare Health Plans after the FBI raided the company in October 2007 in an investigation of overbilling practices. The stock quickly went from $120 to the $20s. We took a couple of months to study it and started buying in the $30s. We saw that the company had a good reputation, its customer service was great, insurance brokers were still sending business to the company, and it was still growing.

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Wellcare shares tanked November 13 after the company said it was being hurt by higher medical costs and was in default on some debt covenants. WellCare is fine. Nothing has changed. If we are wrong on the company, we do not deserve to be in business. What an opportunity!

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And now you also have major positions in UnitedHealth and WellPoint.

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UnitedHealth and WellPoint serve one out of every five insured. They are the insurance system of the United States, and they'll continue to be the insurance system. These companies were the darlings of the investment world not long ago. Whether their stocks are down because of forced liquidations or because of fear that the government is going to put caps on what they can charge, I don't understand the rationale for why these stocks are trading where they are. UnitedHealth will earn between $3 and $3.50 per share of free cash in 2008. That's a significant amount.

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Do you pay any attention to earnings?

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No. I look at free-cash-flow yield.

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And free-cash-flow yield is?

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The free cash a company generates divided by its market capitalization. If we can get a double-digit free-cash-flow yield, I'm interested, especially if we can't kill the company and especially in a world of 3% or 4% risk-free yields.

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Related previous posts:

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Fairholme Fund Conference Call

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Bruce Berkowitz Stays In The Sunshine

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