SPECIAL REPORT. Your Bear Market Insurance A LETTER FROM THE RESEARCH DIRECTOR MAY 2007/BEAR MARKET INSURANCE R E P O R T

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1 SPECAL REPORT SPECAL Your Bear Market nsurance A LETTER FROM THE RESEARCH DRECTOR Dear nvestor, t s not logical but we still feel it. That small sense of satisfaction in the back of our minds each time the sharemarket rises. A little voice tells us that we ve made money because the market price of the shares we own has risen. As my canny old Grandmother Hoffman taught me from an early age, though, you haven t made a profit until you ve actually sold your shares. We all know that in markets, bear runs inevitably follow bulls. And, while it s easy to feel like an investment genius when the market has more than doubled over the past four years, perhaps a part of you is already psychologically preparing for a downturn. But how to do it? n July 2001, The ntelligent nvestor upgraded UNiTAB (then TAB Queensland) to a Buy at $2.76. The All Ordinaries index was trading at 3,298 points. By March 2003, less than two years later, the index was trading at less than 2,700. nvestors in the general sharemarket had suffered a capital loss of more than 18% (it seems that today some people have forgotten what that feels like). But what about UNiTAB shareholders? They were looking at a share price of more than $4.60, a capital gain of 66% in less than two years while most fund managers were going backwards. This is the way value investors prepare themselves for bear markets by picking up safe, reliable investments that hold their value in a falling market. You can bet that when the current tide turns, those who own the right stocks will be smiling while those who ve bought into the fads of today will be licking their financial wounds and swearing off sharemarket speculation for life. t s a cycle that, as a group, investors never seem to learn from. But value investors are different. R E P O R T MAY 2007/BEAR MARKET NSURANCE Five current opportunities n this report you ll find a detailed analysis of five current opportunities five stocks we believe will be the ones that shine when the next bear market arrives. While they won t all be suitable for your own portfolio, we believe there s something here for everyone from those who prefer large blue chip bargains to those who are comfortable taking on more risk in the expectation of greater returns. Take your time reading the research and thinking about what it all means for your portfolio. Philosopher Desiderius Erasmus is attributed with the quote prevention is better than cure we suggest you heed his words. Yours sincerely, Greg Hoffman Research Director

2 SPECAL REPORT/BEAR MARKET NSURANCE The tide turns for nfomedia This producer of electronic parts catalogues isn t out of the woods yet. But things are looking up. NFOMEDA (FM) $0.69 MARKET CAPTALSATON $225m HSTORCAL 12-MONTH PRCE RANGE $0.57 $0.875 FUNDAMENTAL RSK 3 out of 5 SHARE PRCE RSK 3 out of 5 OUR VEW BUY nfomedia provides electronic part catalogues (EPCs) to the automotive industry. t s main product, Microcat, is a comprehensive database of vehicle parts to which dealers can refer when servicing or repairing a car. f, for example, you re a Toyota dealership in Germany, you can subscribe to Microcat and access parts information in German for every Toyota vehicle made since nfomedia sells the product in 160 countries with customers including Ford, Toyota, Daihatsu, Hyundai and Land Rover. At the moment, there are more than 50,000 subscribers to this flagship product. With profit margins in excess of 40% (higher than Microsoft s) it s a pretty attractive business. When nfomedia listed in August 2000, its market-leading position and growth prospects captivated investors. The $1.00 shares quickly soared to a high of $2.65 in November before the prospectus forecasts proved a tad optimistic. nfomedia still grew, but not as quickly as expected. You probably know enough about The ntelligent nvestor by now to guess we wouldn t have been interested as the share price soared. But we are interested in high profit margins and prolific cash generation, at the right price. With the share price down almost 75% from that peak, our $1.20 interest has been sparked. Plummeting share price Over the past few years, everything that could go wrong has gone wrong. nfomedia and its largest competitor, Snap-on Tools, do not own the data they use to produce the catalogues. That data is provided by the nfomedia s rocky road $1.00 $0.80 $0.60 $0.40 Jun 02 Jun 03 manufacturers and, without data, there would be no product. Snap-on and nfomedia dominate the provision of third-party EPCs, with an estimated 90% of the market, but this is only half the story. Many manufacturers produce their own EPCs. Peugeot, in particular, is renowned for having one of the best EPCs in the world. t s an attractive idea for all manufacturers. They own the data, so why not produce the catalogue and keep the profits, and control, for themselves? The answer is that they re car makers not software developers. They generally can t make as good a product as the focused teams at nfomedia and Snap-on, and it tends to cost them more, but that doesn t stop them trying. Three years ago, about 18,000 of nfomedia s 50,000 Microcat subscribers related to one client, Ford Europe. Jun 04 So when Ford Europe decided it would produce its own catalogue to compete with nfomedia, it heralded the first serious setback for the company. This problem was compounded when General Motors North America announced it wouldn t renew nfomedia s data licence in Both losses resulted in serious damage to nfomedia s bottom line but they also highlighted the main risk to the business that the company is dependant on a small number of massive suppliers. t s this risk that still has investors running scared. To its credit, nfomedia s management team has been focused not on its run of bad luck but on improving the company while times were tough. Despite losing more than half of the 18,000 customers from Ford Europe and 3,500 or so from GM North America, the number of subscribers to Microcat are at record levels again. That s because its Toyata business continues to grow and nfomedia has kicked a few goals with Kia and Hyundai. The cycle of insourcing and outsourcing will continue, but we re backing the outsourcing trend to win out in the long term. Superservice takes up the growth mantle nfomedia is also constantly working on developing new products for the automotive industry. With one in particular, it seems to have a winner. Subscriptions to Superservice Menus soared 158% to 1,671 in the financial year to June As at March this year, the number was more than 2,500. The product enables dealerships to provide fast, accurate service quotes, as opposed to the inaccurate and frustrating process you may be familiar with and it looks set to contribute significantly to future profitability. On the costs side of the business, management have used a couple of tough years to cut a large hole in business s overheads and bring the distribution of its products in house. We often see companies make the most significant progress when times are tough and that s definitely been the story with nfomedia. n this case, though, the progress has been hidden by a rising Australian dollar. Half of nfomedia s revenues are generated in US dollars and another third in euros. So the rapid ascent of the Aussie dollar has wreaked havoc with nfomedia s bottom line and covered up all the progress being made on the operations side of the business. That s why we think it s a great opportunity: currency fluctuations will come and go but the underlying business growth will eventually shine through. nfomedia s complete dependence on automobile manufacturers will never disappear. But, given this company s growth potential, a PER of 15 is more than enough compensation for the risk. Best of all, we get paid a 5.8% fully franked dividend yield while we wait for the value to be realised. BUY. Disclosure: nterests associated with The ntelligent nvestor own shares in nfomedia. 2 The ntelligent nvestor PO Box 1158, Bondi Junction NSW 1355 Phone: (02) Fax: (02) info@intelligentinvestor.com.au

3 Timbercorp ripe for picking The market has drastically overestimated the effect of changing tax rules on this agribusiness manager. t looks dirt cheap. TMBERCORP (TM) $2.18 MARKET CAPTALSATON $664m HSTORCAL 12-MONTH PRCE RANGE $1.76 $4.10 FUNDAMENTAL RSK 3 out of 5 SHARE PRCE RSK 3 out of 5 OUR VEW BUY f you have a short attention span, we can sum up this opportunity in a paragraph. There are clouds on the horizon for Timbercorp because, on 1 July 2008, one of its main profit generators will, most likely, be put out of business by the tax office. Mr Market has overreacted, though, and in a big way. The stock is now trading on a PER of around 7, but the company has locked-in future revenue increases, related to past sales, that will almost offset the loss of income elsewhere. t remains cheap, but not as cheap as it was when we first recommended it at $1.85 our first Strong Buy in a long time. Timbercorp sells small farms to investors with a tax problem. Such fortunate souls can lease a 1/4 hectare in future. But, from 1 July 2008, investors in non-timberrelated (that is, horticulture) products will not be able to claim a deduction. Horticulture represented 73% of Timbercorp s operational earnings so it s little surprise that Dutton s axe has lopped a large chunk off the share price. There s still value here though, and lots of it. Annuity stream locked in An almond project runs for 27 years and an olive project 23 years (compared with 10 years for your average timber plantation). Almond trees don t start producing until their third year of life and don t reach maturity until their fourth or fifth year, and Timbercorp receives rent and management fees that escalate as the trees reach maturity. So, whilst upfront profits represent a large portion of total profits right now, there s an annuity stream locked in that will last more than 20 years. Now take a look at Figure 3. Over the past few years, horticulture products have been selling like hot cakes and the annuity revenue from these projects is yet to start flowing. n 2006, annuity-style profit from the horticulture business was $29m. That will more than double over the next few years. By 2009, this part of the business will be generating more than $70m in profit or about $49m SPECAL REPORT/BEAR MARKET NSURANCE Figure 1: Money grows on trees $0.30 Earnings per share $0.25 $0.20 $0.15 $0.10 $0.05 Figure 2: Frost bite $5.00 $4.00 $3.00 $2.00 $1.00 Figure 3: n the pipeline 20,000 Non-forestry hectares under management 15,000 10,000 5,000 FY 03 FY 04 FY 05 FY 06 Jun 02 Jun 03 block of land on which Timbercorp will plant and manage a crop. Your options include timber, olives, mangoes and avocados, but the real attraction is the ability to claim 100% of the investment as an upfront tax deduction. Property booms, stockmarket booms and the lowest unemployment rate in 40 years have generated an unprecedented number of people with tax problems and, as you can see from Figure 1, Timbercorp s business has bloomed accordingly. The share price chart, though, in Figure 2, conjures up images more akin to a cold winter frost than a spring blossoming. Dutton takes axe to almond trees The reason for the dramatic share price fall is that the Federal Minister for Revenue, Peter Dutton, has put the kybosh on Timbercorp s business. With investors in these managed investment schemes (MSs) claiming deductions in the order of $1bn a year, it s not surprising that the Government bean counters have got the hump. The result of a series of Dutton inquiries is that, subject to some ankle-high hurdles, investors in timber-related schemes will still be able to claim a 100% upfront deduction Jun after tax and it s locked in for the next 20 years. At the end of the project the cash will stop flowing from investors but Timbercorp will be left owning land, irrigation and water rights. And don t forget that all deductions will be allowed on projects bought before 1 July 2008, which gives Timbercorp another two financial years to sell new products. f it matches last year s sales (Great Southern Plantations has just announced a 30% increase in sales for the half-year), that would be $158m in pre-tax profits about $111m after tax plus a significant addition to the annuity stream. This is the reason Timbercorp is cheap. t s being priced as if this division is going to disappear. Yet there are still two years of (probably) growing profits to come and, by the time the rules change, the annuity revenue will have grown to the point that, overall, the company won t be earning much less than it is today. We value Timbercorp s horticulture business at $600m. t s comprised of $110m for the post-tax earnings over the next two years plus $490m for the ongoing business [ CONTNUED ON PAGE 4 ] The ntelligent nvestor PO Box 1158, Bondi Junction NSW 1355 Phone: (02) Fax: (02) info@intelligentinvestor.com.au 3

4 SPECAL REPORT/BEAR MARKET NSURANCE Timbercorp ripe for picking [ CONTNUED FROM PAGE 3 ] including a $49m annuity stream for the next 23 years and the value of the land, infrastructure and water at the end. Horticulture pain, forestry gain Then there s the business specifically excluded from the tax office s change in interpretation. Timbercorp owns 91,700 hectares of land on which it manages hardwood timber plantations (the woodchip used to make paper). The company intends to maintain a plantation of approximately this size (90, ,000 hectares) on a year rotation. n other words, it intends to sell 8,000 10,000 hectares of new projects every year, forever. That should generate an annual profit of around $22m or $15m after tax which, using a post-tax multiple of 10, would be worth $150m. While there will probably be more demand for the timber products once the non-timber projects get shut down, we ve got our doubts about this part of the business (see our feature from 4 July 06, Don t be felled by the timber glut). However, the $257m of net assets employed in the forestry division mostly land give us confidence that our $150m valuation is conservative. The majority of investors borrow most, if not all, of the money needed to make their investment from Timbercorp (you wouldn t expect to pay for the tax deduction, would you?). Whilst that has caused the company plenty of cash flow problems over the years it still needs to buy the land and water rights and plant the crops it now has a loan book worth $329m, on which it earns very acceptable rates of interest. But the loans are offset by a large pile of Timbercorp s own debt. n fact, at 30 September 2006, the $565m of debt more than offset the company s combined loan book and cash, to the tune of $87m. So that s $87m we need to subtract from our valuation. Figure 4: Adding it all up BUSNESS There is a risk here. You would think that people with tax problems would have high incomes and would therefore be a good credit risk. But the provision for doubtful debts (an estimate of the percentage of loans that aren t expected to be repaid) jumped from 0.8% to 2.1% last year. No doubt investors aren t too happy about paying loans back if the associated investments aren t providing adequate returns. We ll have more to say about this in a moment but, as we don t think the projects have much chance of providing an adequate return, it s no surprise bad debts are on the rise (although one or two large defaults can make this number swing around from year to year). A significant rise in default rates would put a dent, though not a fatal one, in our valuation. Other odds and ends On top of the traditional MS business, Timbercorp has been building an industrial business to process and sell the produce from the timber and olive projects. Revenue from this business will double to more than $100m this year and it will contribute a few million to earnings. Management tells us the returns have been low because they ve been paying early investors above-market rates, but that they expect to start generating pre-tax margins of 12 18%. We ll believe that when we see it and have put a value of $40m on this part of the business, but it s potentially worth more. Finally, as you can see in Figure 4, we need to add in Timbercorp s $45m stake in the listed company Select Harvests (which manages all of the almond projects). Subtract the corporate overheads and you end up with a per share value of $2.51. There have been a few changes since the last reporting date, including the acquisition of Chiquita Brands and the conversion of preference shares into ordinary shares, but they don t make a significant difference to the per share value. So, as it stands today, the stock is at a 13% discount to our conservative appraisal of the company s value. Significant upside The biggest swing factor in our valuation is the final outcome of the tax office clampdown. While the ATO has indicated it won t be allowing deductions after 1 July 2008, it has asked the industry for a test case to run through VALUE Horticulture business ($m) 600 Forestry business ($m) 150 ndustrial ($m) 40 Select Harvests ($m) 45 Net Debt ($m) 87 Corporate overheads ($m) 50 Total ($m) 698 Shares on issue at 30 Sept. (m) 278 Value per share ($) 2.51 the courts before then. We ve assumed the worst case, but there s a reasonable chance of the non-forestry MS industry eventually resuming with similar restrictions as those applied to the forestry industry. That would add dollars per share to the valuation. A few more years of record sales could make our estimate of the annuity stream seriously undercooked. Management s estimate of the annuity stream, as things stand, is significantly above ours and the industrial business could be much more valuable than we ve estimated. n short, if a few things go the company s way, the value could be multiples of the current share price. Our main concern is that the tax driven investors who buy Timbercorp s products could end up very disappointed with the returns they receive. Farming isn t the most profitable game to start with and, with Timbercorp grabbing more than its fair share, its hard to see how much of the pie can be left for those investors. As shareholders, though, most of the profits will be in the bag, but it does make you think twice about owning this business. What that means for your investment decision we ll leave up to you. But what we can say is that Timbercorp is dirt cheap. Even if the whole MS sector comes to a screaming halt as investors realise the error of their ways, Timbercorp has ridden the wave to become one of the major landowners and farmers in Australia. t is going to continue making money for a long time to come. Our original recommendation was STRONG BUY but the share price has risen somewhat since then. As a result, we ve downgraded to BUY. Disclosure: nterests associated with The ntelligent nvestor own shares in Timbercorp. 4 The ntelligent nvestor PO Box 1158, Bondi Junction NSW 1355 Phone: (02) Fax: (02) info@intelligentinvestor.com.au

5 Hidden value in Souls Private This company is doing things differently and its directors have been buying. Should you follow suit? SOULS PRVATE EQUTY (SOE) $0.24 MARKET CAPTALSATON $142m HSTORCAL 12-MONTH PRCE RANGE $0.17 $0.28 FUNDAMENTAL RSK 3 out of 5 SHARE PRCE RSK 2.5 out of 5 OUR VEW BUY UP TO $0.23 The thicker the carpet, the thinner the dividend, Jim Millner was fond of saying. As chairman of the Soul Patts empire for many years, he kept costs on a tight rein. Were he still alive, we wonder what he d make of the generous fee structure in place at Souls Private Equity, an investment company offshoot of Washington H Soul Pattinson. Private equity funds are renowned for paying huge fees to their managers. Souls Private is no exception, with the manager charging a base fee of 1.75% of net assets and 15% of any returns on its investments exceeding 10% a year. The base fee last year alone worked out at $2.7m. Not bad for a company with a market capitalisation of just $128m. The management fees are obscene. But a cheap stock price forgives many sins. At 31 March Souls Private had net tangible assets (NTA) of $0.28 per share, against a current share price of $0.24. That 14% discount looks attractive in its own right, but the situation is even more interesting as we ve uncovered some hidden value (something of a recurring theme with these Soul Patts-related entities, with Brickworks being another example). Accounting convention f this financial jar s label reflected its contents, it would read something like Souls Private Equity/Venture Capital/ Listed nvestment/cashbox. At 31 January 2007 only half the portfolio was in unlisted investments and a bit less than a quarter was in pure private equity. By accounting convention, the unlisted investments are recorded at their cost price in the accounts but there can be a big difference between this accounting value and the actual economic value. And that s the key to this opportunity. The linchpin of our hidden value thesis is Souls Private s 45% investment in Ampcontrol, an electrical manufacturer and supplier to industries including mining, oil and gas. Souls Private bought into this company less than two years ago and it s shaping up to be an excellent investment. Last year Ampcontrol earned $2.4m for Souls Private. And, in the first half of this year alone, it made $2.8m. f a similar amount can be produced in the second half, it will contribute $5.6m after tax to Souls Private this year. Voracious appetite for resources Ampcontrol has a heavy reliance on the resources sector and is benefiting from the current boom, so we need to be careful about extrapolating recent earnings far into the future. But at a valuation of 10 times net profit, Souls Private s stake in this company would be worth $56m. t s in the books at only $16m. That $40m difference amounts to about 6.5 cents a share. And, judging by investors current voracious appetite for all things resources-related, the stake could potentially be sold (perhaps through a float) for tens of millions more than this figure. Souls Private s stake in Food & Beverage Company (FBC) is also interesting. FBC itself owns a number of investments, including 24% of the high-profile Krispy Kreme Doughnuts Australia. While the financial performance of this investment has been disappointing to date, our discussions with management indicate that expectations remain buoyant. FBC s other investments include Jesters Pies and Belaroma Coffee. A proposed float last year would have raised up to $125m for the company. While that amount proved ambitious, we wouldn t be surprised to see Souls Private sell out of this investment for a tidy profit in a few years. No one-trick pony Souls Private also has a decent track record of completed deals. n December 2005, the company made a $3.8m investment in listed drilling services company mdex. Soul searching $0.30 $0.25 $0.20 $0.15 Dec 05 Dec 06 That stake was gradually reduced and, by the time the sell-off was completed recently, Souls Private had more than doubled its money. Hydramatic Engineering was another quick turnaround. A stake in this business was sold for a pretax profit of up to $9m (depending on some adjustments) less than two years after making an initial investment of only $4m. Directors jump on board So we think we can see some value in this stock, and it s reassuring that three directors seem to agree. David Wills, Robert Westphal and chairman Rob Millner have all increased their holdings recently (see our website for details). n summary, we re ambivalent about private equity in general (and mindful of the risks), and we re not fans of Souls Private s fee structure. But this stock simply looks too cheap, and it s more diversified than the garden variety private equity fund. Our valuation of the group s assets stretches to the mid-30 cents range. Though we re inclined to knock off, say, 15% for the fees and settle on an intrinsic value just north of 30 cents per share. Based on that, Souls Private Equity is a BUY to 23 cents. Disclosure: nterests associated with The ntelligent nvestor own shares in Souls Private Equity. SPECAL REPORT/BEAR MARKET NSURANCE The ntelligent nvestor PO Box 1158, Bondi Junction NSW 1355 Phone: (02) Fax: (02) info@intelligentinvestor.com.au 5

6 SPECAL REPORT/BEAR MARKET NSURANCE Soul Patts has the right formula This investment company knows how to manage its affairs it s been getting it right for over a century. WH SOUL PATTNSON (SOL) $9.43 MARKET CAPTALSATON $2.2bn HSTORCAL 12-MONTH PRCE RANGE $7.20 $9.74 FUNDAMENTAL RSK 2 out of 5 SHARE PRCE RSK 2.5 out of 5 OUR VEW LONG TERM BUY The first thing you ve got to understand, Rob Millner told us recently, is that Soul Patts is Australia s third-oldest listed company and was formed over 100 years ago. Millner is chairman of Washington H Soul Pattinson and we were talking to him as part of our research for this article. He is a fourth-generation servant of the company which was listed on the stock exchange in From its humble beginnings with a single pharmacy, the company has expanded into brick making, bakeries, investment banking, coal mining and a range of other activities. And the Soul Patts line of heirs could extend at least another generation. There are currently two members of the clan working in the private equity and funds management businesses. Both are potential candidates to continue the company s rich tradition. mpressive track record We last looked at the company in issue 179/Jul 05, in an article titled Hats off to the Millners, though we didn t offer a formal recommendation. We doffed our caps to the company s impressive track record but didn t see enough value in the stock to recommend an investment. Since then the stock price has barely moved, while our assessment of value has increased. That makes the equation much more interesting. So where s the value? Because of its diverse range of investments, Soul Patts lends itself well to a sum of the parts valuation. t s particularly helpful that most of the Old company, New Hope $12.00 $10.00 $8.00 $6.00 $4.00 Jun 02 Jun 03 parts are listed on the stock exchange, but it s a little more complicated than simply taking each of their current market values and totting them up. Firstly, given that Soul Patts owns a large percentage of many of these companies, it probably couldn t achieve the market price if it wanted to offload its holdings. Secondly, we need to be satisfied that the stocks owned aren t substantially overvalued. The table on the next page shows a summary of the company s major investments. While Soul Patts has a wide variety of businesses, almost 90% of its value is accounted for by just three divisions: Brickworks, New Hope Corporation and the listed share portfolio. First on the list is Brickworks. The company is primarily a brick maker, as its name suggests, and it operates the Austral, Bristile and Eureka tile and brick businesses throughout Australia. But like Soul Patts, Brickworks has a Jun 04 number of other investments. As well as an interest in a namesake listed investment company, Brickworks also has a burgeoning property development business and owns an extensive property portfolio (see issue 65/Oct 00 (LONG TERM BUY $4.30) for more details). The majority of the properties are situated in New South Wales, which has seen soaring land values over the past decade although the last few years have been more subdued. The total value of the land could be as much as $1bn, yet it s on the books at only a couple of hundred million dollars. Complicating matters, Brickworks holds a 43% crossshareholding in Soul Patts. This investment was made decades ago as a defence against the corporate raiders of the day and it appears unlikely to be unwound any time soon. We last reviewed Brickworks in issue 209/Sep 06 (AVOD $11.11), but we ve become more positive since then and we re currently looking at the stock in more detail. New Hope Next on the list is New Hope Corporation. Coal mining isn t a business that particularly excites us, especially when the stock is trading on a historical PER of 16 in the midst of a resources boom. But there are some positives for the company. The most reassuring of these is that, after the sale of its ndonesian coal assets in June 2005, New Hope is sitting on a stack of cash $364m at 31 July While a substantial portion of this will be needed to fund New Hope s developments in Central Queensland, there should be plenty left to return to the company s shareholders if that s deemed the best use of capital. Still, of all Soul Patts investments, New Hope looks the riskiest. Soul Patts also maintains a large listed share portfolio. You won t find many speculative mining companies on this list. As conservative investors, Soul Patts sticks to old chestnuts like the big banks and other listed investment companies. At the time of its annual meeting, the portfolio s value was $483m, but considering the run up in the market over the last few months it is likely to be more than that now. Other investments SP Telemedia is the largest of the company s other investments. We ve had positive recommendations on this company in the past and currently think it fair value you can read all our reviews on the website. Australian Pharmaceutical ndustries is a wholesale supplier of pharmacy items. Soul Patts acquired an interest in this company when it sold its own pharmaceutical interests to AP in The share price of this company has taken a hit lately as some accounting anomalies have put a major dint in this year s forecast profit. The good news is that the company is under siege from predators. 6 The ntelligent nvestor PO Box 1158, Bondi Junction NSW 1355 Phone: (02) Fax: (02) info@intelligentinvestor.com.au

7 We re happy with the valuation of the AP stake. f AP can t fix its problems soon, then it s likely that Soul Patts will give in to the predators and sell its stake at a price significantly higher than today s. The final item on the list is a value for all the company s other businesses and balance sheet items, less some liabilities and corporate head office expenses. The assets include investments in Souls Funds Management and Pitt Capital Partners (an investment banking operation), of which the company owns 64% and 50% respectively. Soul Patts also still operates a number of pharmacies through its parent entity and we ve attributed a small value to that. There s also a $10m seed capital investment in Souls Select Australian Share Fund, $53m in loans to related parties and about $76m in net cash. The liabilities side On the other side of the ledger, the company has a $95m deferred tax liability. Also, even though the Millners run a tight ship, the executive team and other head office staff don t work for free and we ve deducted $36m from our valuation as a capitalisation of head office costs. n all, other adds up to $56m. The overall total of the investments, assets and other items comes in at $2.7bn, or about $11.15 per share, which stacks up nicely against the current share price. By our calculations, you are getting about a 9% W H Soul Pattinson sum of the parts NVESTMENT SHARES (M) SHARE PRCE ($) VALUE ($M) % OF TOTAL Brickworks New Hope SP Telemedia Aust. Pharm. nd Souls Private Equity Listed Share Portfolio Other Total 2,665 Shares on ssue discount by purchasing Soul Patts compared to the underlying value of its investments. 239m Value Per Share $11.15 Favourable comparison This compares favourably with another large conglomerate, Wesfarmers. Like Soul Patts, Wesfarmers operates a number of businesses and also derives a substantial part of its income from coal mining. n our review of Wesfarmers in issue 181/Aug 05 (Hold $39.95), we conducted a sum of the parts valuation similar to the one we ve done here, except that we came up with a value which, at approximately $31.50 a share, was a long way below the share price at the time. The value of Wesfarmers has probably increased since then, but not enough to match the 22% premium to this figure at which the stock currently trades. On a long-term basis, Wesfarmers has been a stellar performer and that may justify the chunky premium. But we prefer to buy stocks without too much blue sky in their price and Soul Patts fits the bill nicely. There is another reason to like Soul Patts its consistent record of increasing dividends. The ordinary dividend yield for the company is reasonably low at 2.9%. But, when the special dividend is included, it rises to a more respectable 4.5%. And Soul Patts is one of those companies where the special dividend isn t really that special. The company has been a regular provider of special dividends throughout its history and has paid at least one every year since the turn of the new century. Not guaranteed but likely Of course there is no guarantee that the special dividends will continue, but we d be surprised if the company cut them off now. There is certainly plenty of cash available in the investee companies (particularly New Hope, which also has a decent bank of franking credits available) which could find its way to Soul Patts at some point, to help fund future special dividends. Despite all the positives, though, Soul Patts is no surefire investment. Firstly, there are the risks associated with each of the individual investments. For example, New Hope is susceptible to any downturn in the coal price. Brickworks core business is notoriously capital intensive and competitive. Also the housing cycle has peaked (well, maybe not in Perth), so this division could be in for some tough times over the next few years notwithstanding any untapped value in the property development business. Also, the sharemarket in general has had a spectacular run over the past few years and a bear market would likely impact the value of the listed share portfolio. A significant decline in any of these investments could quickly erode the discount that currently exists between value and price. Shareholders money Any investment in Soul Patts also requires a large degree of faith in the Millner clan. This isn t so much a risk, but rather an understanding that if you invest in the stock you are effectively entrusting the management of your money to the extended Millner family. As we mentioned before, though, this isn t necessarily a bad thing. When we spoke to him, Millner said a few things that sit very comfortably with our own investment philosophy. When we asked whether any assets in the group were sacrosanct, for example, Millner quickly dispelled that notion. At the end of the day, he said, it s shareholders money, and our job is to protect it and do what is best for them. And, when discussing the market in general, he explained: One of the reasons the private equity fund has so much cash is that it s hard to find bargains right now. All this is backed up by an impressive track record. And the fact that the Millner family still has a substantial shareholding in Soul Patts provides further assurance that management will indeed put shareholders first. Soul Patts is a classic bottom drawer stock. You tuck it away and sit back to watch the dividends and share price grow. Based on these attractive attributes and the current discount to the fair value of its investments, we rate Soul Patts a LONG TERM BUY. Disclosure: nterests associated with The ntelligent nvestor own shares in Soul Pattinson. SPECAL REPORT/BEAR MARKET NSURANCE The ntelligent nvestor PO Box 1158, Bondi Junction NSW 1355 Phone: (02) Fax: (02) info@intelligentinvestor.com.au 7

8 SPECAL REPORT/BEAR MARKET NSURANCE The good oil on ROC Oil is a precious commodity and Roc Oil is an expert at finding and producing it. ROC OL (ROC) $3.33 MARKET CAPTALSATON $993m HSTORCAL 12-MONTH PRCE RANGE $2.77 $4.32 FUNDAMENTAL RSK 4 out of 5 SHARE PRCE RSK 4 out of 5 OUR VEW BUY Roc Oil is another conservatively financed, well-managed company with a great track record, but it is an oil explorer and that s about as racy as we get. We first recommended Roc back in issue 130/Jun 03 (BUY $1.13). t is somewhat out of character for us to be still recommending a company after its share price has almost trebbled in such a short space of time. This unusual state of affairs has come about because our assessment of Roc s intrinsic value has moved up at least as quickly as its share price. There are two parts to the equation: the assets the company owns that are already producing which are relatively easy to value and its exploration assets which are nigh on impossible to value. On the production front, Roc has a number of projects, located in Western Australia, Mauritania, China and the United Kingdom, that are either producing or nearing production. n issue 208/Sep 06 (BUY $3.34) we took a look at each of these projects in some detail. You should read that review, as we don t have the space here to review Rocking good value $5.00 $4.00 $3.00 $2.00 $1.00 Jun 02 Jun 03 each of the assets, but when we add it all up we estimate their combined worth at about $5 per share (after adjusting for the recent rights issue). You ll notice straight away that this estimate is more than the current share price. That s the way we like it the exploration potential, which is very difficult to value but definitely worth something, is thrown in for free. Prospective territory This is where the big upside lies. The company has a number of prospective exploration assets, particularly in China and Angola. Top of the list is Angola. Management bought into the area in 2001, amid a civil war, and paid an absolute song for the block. About a year later, the Jun 04 country emerged from the funk of its 27-year civil war and Roc was left in pole position to explore this very prospective territory. The company has already spent tens of millions gathering data (and clearing the civil war s leftover landmines), and will spend plenty more. t plans to drill three holes in Angola this year, and potentially another three depending on various factors. The first two wells, Massambala-1 and Caju-1, are being drilled by separate rigs and are both scheduled to commence in May or early June. Since we re getting the potential for free, we ll be quite prepared to see a series of dry holes, but we think there s a very good chance of Roc striking commercial quantities of oil somewhere among these (up to) six wells this year. Then there s China. n May 2006, the company announced a significant oil find in the South China Sea, an area that has proved to be a great oil and gas resource over the years. Roc s Wei-6-12S-1 well is a few kilometres from the earlier Wei discovery, which in turn is only a few kilometres from oil lines owned by China National Offshore Oil Corporation (CNOOC) which run to the Weizhou sland Oil Terminal. Being close to CNOOC infrastructure, and considering CNOOC s option to buy into the project, the economics could be mouthwatering. Management icing on the cake The final clincher is that we re big fans of the management team. Roc s annual reports specifically the commentaries by chief executive John Doran are some of the best we ve seen. Doran is approachable, candid and honest and he has decades of experience (including plenty of success) in the industry. You can listen to interviews with him yourself at our own website or Of course, it is the oil game and that means we should never get carried away. The risks are numerous, including the oil price, political instability, skyrocketing costs and the usual operational risks involved in the resources game. Whilst we think Roc s great value, the nature of the industry and the countries in which Roc operates mean there is a speculative dimension to this stock, so we recommend that you limit it to 8% of your portfolio even if you have a high tolerance for risk. BUY. Disclosure: nterests associated with The ntelligent nvestor own shares in Roc Oil. WARNNG This publication is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, seeking advice from a financial adviser or stockbroker if necessary. The ntelligent nvestor and associated websites are published by The ntelligent nvestor Publishing Pty Ltd (Australian Financial Services Licence number ). DSCLAMER This publication has been prepared from a wide variety of sources, which The ntelligent nvestor Publishing Pty Ltd, to the best of its knowledge and belief, considers accurate. You should make your own enquiries about the investments and we strongly suggest you seek advice before acting upon any recommendation. COPYRGHT The ntelligent nvestor Publishing Pty Ltd No part of this publication, or its content, may be reproduced in any form without our prior written consent. DSCLOSURE At the time of publishing in-house staff held shares in AEA, AHC, AMO, ANZ, ARP, CBA, CHF, COH, COS, CRS, CXP, DBS, DEX, FLT, GFF, GLB, GNC, GTP, HHVO, HVN, AS, FL, FM, VC, JBH, JST, KRS, LMC, LWB, MBL, MLB, MMA, MRC, NABHA, OEQ, ORL, QMT, ROC, SFC, SFH, SGB, SGN, SOF, SPT, STO, TGR, TM, TLS, TLSCA, TRS, WAL and WDL. This is not a recommendation. Prices correct as at date of publication,8 May The ntelligent nvestor PO Box 1158, Bondi Junction NSW 1355 Phone: (02) Fax: (02) info@intelligentinvestor.com.au