Portfolio Concentration

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    HOW CONCENTRATED SHOULD YOU BE?

    HOW

    CONCENTRATEDSHOULD YOU BE?

    RE-EXAMINING THE BIG BET THEORY

    VALUE INVESTING CONGRESS WEST

    May 8, 2007

    PRESENTED BY:

    Zeke Ashton

    Centaur Capital Partners

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    Some Small Ideas are Worth Having

    Value investing literature is heavy with the concept ofconcentration, with which we generally agree. However, we

    believe that running super-concentrated portfolios requires acombination of manager and capital base attributes that only aselect few investors truly possess.

    Our view is that not every idea has to be worthy of a very largeposition allocation to be included in our portfolio so long as eachidea adds an unique element that contributes something to the

    favorable asymmetric payoff profile for the portfolio as a whole.We will present four such ideas for you today.

    Our experience is that we frequently come across excellent ideasthat do not justify large position sizes but which have had a

    beneficial effect on our performance. We believe that combining a concentration of our best ideas at

    the top of the portfolio with a number of smaller bets at thebottom of the portfolio has improved both our returns and the

    reliability of those returns.

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    There are Many Ways to Value Investor Heaven

    Value comes in many forms. You can choose to specialize incertain areas, or you can learn to recognize and take advantageof all types of value opportunities. We like to look for value in allits guises.

    Some idea types justify a significant deployment of capital whileothers are better suited to small percentage probability bets.

    Below is a non-exhaustive list of 18 Categories of Value Ideas(from Value Investor Insight):

    Out-of-favor blue chips StubsOut-of-favor cyclicals Net-NetsDistressed industries Discounts to CashTurnarounds Declining Cash Cows

    Overlooked Small Caps Oddball CompaniesFallen Growth Angels Sum-of-the-PartsGARP (Growth At Reasonable Price) Activist OpportunitiesSpin-offs Post-bankruptcies

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    Idea #1: Hennessy Advisors (HNNA)

    Asset manager that offers a family of six mutual funds using themechanical formulas developed by James OShaughnessy in his bookW hat W orks on W all Street.

    Business model is to acquire assets of other mutual funds at cheap

    prices and roll those assets into one of its existing funds or a new fund. In 2000, acquired the two OShaughnessy funds with $197 million

    under management along with the rights to the mechanical strategies,for $5 million (2.5% of AUM).

    In 2004, acquired Lindner Asset Managements mutual funds, with$300 million under management, for $8 million (2.625% of AUM).

    In 2005, acquired Henlopen Funds with $300 million in AUM for $6.75million (2.25% of assets).

    As of March 31, 2007, total Hennessy AUM was $1.9 billion, up from

    $835 million at December 31, 2003. The stock has also more thandoubled during that time.

    5.7 million shares outstanding, recently at $14.25, for an $80 M marketcap.

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    Idea #1: Hennessy Advisors (HNNA)

    Hennessy Funds have very competitive returns and very low costs, withmanagement fees of 60-75 basis points.

    Hennessy Focus 30 has a five-star Morningstar rating. ($200M AUM)Hennessy Cornerstone Growth has a four-star rating. ($1.2 B AUM)

    Hennessy has 11 total employees ($172 M AUM / employee) and verylight cost structure. There are no expensive portfolio managers oranalysts to pay.

    Founder and CEO Neil Hennessy takes a modest salary and an annualbonus of 10% of pre-tax profit. We believe this is a fair arrangement forshareholders.

    Hennessys pre-tax operating profit margins have increased from 37%in 2003 to 47% in 2006 due to inherent scale in the business.

    At the recent price, HNNA trades for approximately 13-15X ourestimated range of 2007 free cash flow of $5.5 - $6 million.

    We see no reason why HNNA will not be able to sustain its magicformula for many years, growing AUM organically and via acquisition.

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    Idea #2: Collectors Universe (CLCT)

    Collectors Universe is a leading provider of authentication and gradingservices to dealers and collectors of high-value coins, sports cards,stamps, vintage currency and autographs.

    The company has recently made an aggressive entry into the

    authentication and certification of diamonds and precious gems.

    CLCT occupies a unique and potentially lucrative niche as anindependent third party expert to certify the quality and authenticity ofhigh-value specialized merchandise.

    The company may become a very long-term growth play on the increasein sales of sight unseen channels for high dollar collectibles andmemorabilia, such as eBay, Blue Nile, Amazon.com and others

    The company has also developed and acquired some subscription-

    based information service businesses that compile and provide marketinformation to dealers and collectors using the proprietary andpotentially valuable information gathered via its authentication andcertification businesses. This adds potential for both recurring

    subscription revenue and advertising revenue.

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    Idea #2: Collectors Universe (CLCT)

    With 8.3 million shares outstanding at $14.00 recent price, CLCT has amarket cap of $116 million.

    The company has approximately $45 million in cash, or almost $5.42per share. EV is therefore ~$70 million.

    The mature and competitively entrenched coin grading business lookslike a very steady cash cow that benefits somewhat from rising gold andsilver prices. We believe this business kicks off something like $8million per year in free cash flow.

    The sports card business is modestly FCF positive (~$1 million peryear, but the stamp, autograph, and currency businesses are notprofitable. The diamond and gem business is currently unprofitableand isnt expect to reach cash flow profitability until 2008, masking the

    true profitability of the core business. We see two ways to win: the new businesses become profitable and

    enhances shareholder, or they dont work and managementdiscontinues investing in them and monetizes the assets. The true

    earnings power of the core business would then be revealed.

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    Idea #3: Stewart Information Services

    Stewart is the fourth-largest provider of title insurance and real estateclosing services in the U.S. with 10% market share.

    The title insurance industry is an oligopoly with very rational operatorsand significant barriers to entry. Top five players have 90% share.

    With 18.2 million shares out and recent price of $40.50, market cap isabout $735 million.

    Stewart reported revenue of $2.47 billion in 2006 and $2.4 billion in2005.

    Average FCF per year for years 2001-2005 was $118.7 million. Thecompany has not been FCF negative in any of the last 20 years.

    Tough year for real estate in 2006 caused operating earnings to drop by

    50% from $165 M to $85 M. FCF dropped to $40 million due to lowermargins and higher cap-ex on technology spending in 2006.

    STC may be over-capitalized by $100 million and is using its cash toacquire title agencies during the real estate downturn.

    Trades at 6X mid-cycle FCF and 0.9X book value.

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    Idea#4: Ag Growth

    Ag Growth is a highly profitable and well-run manufacturer ofagricultural equipment.

    The company has a dominant market share in its specialized niche ofgrain handling and storage equipment.

    Went public in summer of 2004 as a Canadian Income Trust. Highly profitable business with gross margins of ~45% and

    distributable cash flow margins of ~23-25%.

    Business is much more stable than the highly cyclical cash crop

    industry because Ag Growth produces relatively low cost equipmentthat requires replacement every few years and because use of itsproducts is tied to crop volume, not price.

    Ag Growth is consolidating the fragmented industry by acquiring highquality competitors at accretive prices.

    We believe that Ag Growth stands to benefit from a confluence ofbeneficial long term trends driving higher grain volumes, particularlycorn, due to the rapid development of the corn-based ethanol industryin the U.S., as well as growing demand for corn and other grains

    worldwide.

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    Idea#4: Ag Growth

    There are 11.225 million units outstanding at recent price of $C22.55,for a market cap of $C250 million.

    Company ended 2006 with $32 million net debt, for EV of $C282million. 2006 reported revenue was $C81.5 million and FCF was

    $C22.5 million. Ag Growth announced acquisition of Hansen Manufacturing, a

    manufacturer of grain handling products under the Hi-Roller brand,for $18.5 million financed by debt. Ag Growth paid 5X 2006 EBITDAfor Hansen, which is a growing business.

    At approximately 10X FCF and yield of 7.5%, Ag Growth is a cheap andsafe back door play on the ethanol industry.

    As a Canadian Income Trust, the company will pay no taxes until 2011,and therefore has about four years with which it can make accretive

    acquisitions in its industry and benefit from the favorable taxtreatment.

    We believe Ag Growth will still be reasonably priced when it beginspaying corporate taxes in 2011; free call option on a favorable change inCanadian tax policy between now and 2011.

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    Why Arent These Bigger Ideas?

    Hennessy is an illiquid stock and something of a probabilisticbet on continued asset growth and acquisitions. We have itsized at about 1.7%, but it has been bigger in the past.

    Collectors Universe is a probability bet that appears to offer anasymmetrical risk / reward profile. The downside appears to beprotected, and the stock appears to offer some potentially very

    valuable free call options. However, it is hard to quantifyvalue or the timing of the payoff of these potential call options.

    We have it sized at 1.5%. Stewart appears to be both safe and cheap. However, we also

    own two other title insurance stocks (FAF and FNF) and we likeSTC as part of our title insurance basket because STC may work

    out at a different time for different reasons than FAF or FNF.STC is sized at about 2.5%.

    Ag Growth appears to be a high quality business at a reasonableprice with strong winds at its back. Illiquidity is the primary

    concern. We sized it at 3%.

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    Common Value Investor Portfolio Models

    There are several common portfolio models used by successfulvalue investors that we have come across:

    Ultra-Concentrated Portfolio Model

    Definition - Fewer than 10 stocks with large position sizesroutinely comprising 20-25% of portfolio assets and larger.

    Practitioners: Chieftain, Eddie Lampert, Tom Brown,

    The 10 Stock Model

    Definition - Standard position size of around 10%, though theremay be one or two larger positions, and a handful of smallerpositions for a total of 12-20 ideas.

    Practitioners: Mohnish Pabrai, Clipper,

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    Common Value Investor Portfolio Models

    Standard 20-Stock Model

    Definition Standard position size for a good idea is about 5%,though best 2-3 ideas may be modestly larger and many ideas

    are somewhat smaller. Total portfolio of 25-40 ideas. Practitioners: Many of the value mutual fund managers on the

    previous slide: Robert Hagstrom, Bill Miller, Wally Weitz,Longleaf Partner, Tweedy Brown Value, etc.

    20-Stock Model (Super-sized)

    Essentially the same as standard 20-stock model, but two or

    three best ideas are super-sized to 10-15% of the portfolio, andthere are fewer sub-5% positions. Total of 20-30 ideas.

    Practitioners: Tilson Focus, Fairholme, Sequoia, OakmarkSelect

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    The Centaur Portfolio Model

    LONG POSITIONS6.0% - 7.5% Outstanding Idea, 1-2 Best per year, combines

    compelling valuation with significant margin ofsafety.

    4.0% 6.0% Standard Great Idea, usually will be one of our topeight to ten ideas.

    2.5% 4.0% Solid or even excellent idea with one or moreminor risk factors, which might relate to business

    or industry quality, valuation, liquidity, politicalrisk, or level of our conviction and ability tocompletely understand all aspects of the business.

    0% - 2.5% Interesting and sometimes compelling idea that

    may be very illiquid, may be a probability bet witha favorable asymetrical reward to risk ratio, or maysimply be a low quality business that is very cheaprelative on a NNWC or price / tangible book value

    basis.

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    The Centaur Portfolio Model

    SHORT POSITIONS>4% Generally reserved for shorts or hedges involving

    the use of broad market or sector specific indices.

    3-4% Most compelling individual short idea where webelieve risk is very low.

    2-3% Standard Excellent Idea, usually will have no morethan two or three shorts of this size.

    1-2% Solid or even excellent short idea with one or morebut certain risk factors to the short thesis might bepresent, such as high short interest, low float, lowmarket cap, etc.

    0% - 1% Generally reserved for short ideas utilizing a put

    option instead of common, where the probability ofa good outcome might be low but the magnitude ofa positive outcome might be significant to ourperformance.

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    The Reliability Payoff

    Its not about reducing volatility, its about increasing reliability.

    We want enough ideas to ensure that our sample size is bigenough to reward skill and absorb the occasional bad outcomes,

    bad decisions, bad timing, or bad luck.

    Adding in a mix of five to ten short ideas further improvesreliability.

    A CATALOG OF CENTAUR CAPITAL WORSTS

    Worst calendar quarter Q2 2006 -1.2%

    Worst rolling three months May-July 06 -4.8%

    Worst peak to trough decline Summer 06 -7.0% (approx.)

    Worst rolling 12 months YE July 06 +12.9%

    Worst calendar year 2006 +13.7%

    Note: For ease of com parison, all w orstsare reported net of m anagem ent fees but before incentive fees.Annualized returns from inception for our longest tenured fund (Centaur Value Fund) from August 1,200 2 March 31, 2007 net of m anagem ent fee but before incentive fee were approxim ately 23%.

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    Maxims Regarding Position Size

    The goal for all investors should be to get the most value out ofyour best ideas without risking significant capital loss if you arewrong.

    Concentration isnt a constant it is idea and environmentdependent.

    Your philosophy on selling will determine to some extent howmany positions you hold at any one time.

    The more concentrated you are, the more rigorous you have tobe and the more good ideas you have to reject.

    The more ideas you have, the harder you have to work.

    Factor diversification can be a good thing.

    Sample sizes matter. A certain minimum number of ideas isrequired to protect skillful investors from the capriciousness ofluck and unexpected bad outcomes.

    If you cant sleep well at night, either you dont own the right

    stocks or you are running too concentrated a portfolio.

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    Practical Questions to Ask Yourself

    What type of portfolio is consistent with your portfolio andpersonal risk / stress tolerance? Can you sleep at night if you

    have -10% months? 25-30% peak-to-trough declines? What are your goals maximum returns (with the assumption

    of significant volatility) or satisfactory returns within a certainrisk profile?

    How many ideas can you process and maintain? What kind ofideas do you prefer?

    How stable is your capital base? Are your investors prepared forsignificant volatility? Do you have safeguards in place to protect

    your capital from fleeing at the worst possible time?

    Do you work best alone or do you prefer a team environment? Ateam is going to generate more ideas than a solo practitioner.

    i l h h

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    Final Thoughts

    Confronted with the challenge to distill the secret of sound investmentinto three words, we venture the motto, MARGIN OF SAFETY.

    -- Benjamin Graham, Intelligent Investor

    Why is having a margin of safety important?

    Valuation is an imprecise art

    The future is inherently unpredictable

    Having a margin of safety provides protection against bad luck,bad timing, or error in judgment.

    We believe that the principle of margin of safety is just asapplicable to portfolio construction as it is to individualinvestment selection.