Distress is the road to understanding

Benj Gallander and Ben Stadelmann
Saturday, July 14, 2001

While on a US tour visiting some of the movers and shakers of the American stock world earlier this year, the Contra Guys landed in the luxurious New York office of seasoned veteran Marty Whitman, who manages the $2.4 billion (US) Third Avenue Value mutual fund.

Mr. Whitman is our kind of guy, a man who has been involved in the investment biz for much of his 70-plus years, hangs out with people named Warren Buffett and Mario Gabelli, and moves around the office in a lumberjack shirt, casual slacks and jogging shoes.

Understandably, Mr. Whitman is a busy man. When we gave him a shout he said gruffly, “How long do you want to get together for?”

“An hour,” was the response.

“An hour!” A simple tabulation registered this was thousands of dollars worth of his time.

Mr. Whitman, the author of Value Investing, A Balanced Approach,was a pioneer in two arenas a respected investment banker wouldn’t touch: stockholder litigation and bankruptcy. His focus is buying the corporate bonds and bank debt.

The key to the strategy? Getting more than one paid, he says. His first huge deal was the Penn Central calamity in the ’70s. Another transaction was the merger of Equity Strategies and Nabors in the early ’90s, the stock having skyrocketed since. Recently he bought bonds of troubled utilities Pacific Gas and Electric and California Edison, with yields of 25.5 percent and 21 percent, respectively.

The enormous size of the deals means that if one sours, the losses are huge. Mr. Whitman suggests that companies get into trouble for two reasons: Bad finances or poor management. He only looks for businesses with the former. He is content to retain the top brass and believes it is critical to give them a stake in the business’s success.

Mr. Whitman fully admits that he operates in a cutthroat arena and the nature of the business is confrontational. Fifteen minutes into our discussion he seems anything but, and we ask how he deals with the industry’s belligerence.

With a wry smile he says, “I have people who work for me.” Indeed, he keeps a staff of 100 busy, which is one reason he only looks at large plays, as administration costs of $10 million to $20 million on a transaction easily eat up profits.

Prior to their recent Chapter 11 filing as a result of litigation claims, Mr. Whitman invested in US Gypsum, buying about $65 million of their bonds. This firm is involved in the building materials field, and asbestos has been its bane. The firm has been named in more than 250,000 personal injury claims.

About 10 years ago, US Gypsum was valued at more than $300 a share, while today it fetches a piddly $4 and change, with a book value about three times greater and sales exceeding $3.5 billion. Other troubled giants in the field include Armstrong Holdings, Crown Cork & Seal, Federal-Mogul, Owens-Corning, Owens-Illinois, and W.R. Grace. When all the companies in a field trade at moribund levels, that is generally a signal that a tremendous buying opportunity exists.

These firms are on our Stock Watch List, companies that we could swoop in to purchase. For the moment though, patience is our virtue, as we remain hopeful that some of these organizations will soon be further around the turnaround bend, while priced even more cheaply, as a result of end-of-year tax loss selling.

Before ushering us out the door, Mr. Whitman stated: “Distress is the real road to understanding value. Remember, the value to a recipient doesn’t necessarily compare to the cost.”