Dhandho! Low Risk + High Uncertainty = High Rewards. Mohnish Pabrai Managing Partner.

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1 Dhandho! Low Risk + High Uncertainty = High Rewards Mohnish Pabrai Managing Partner

2 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.

3 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!

4 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.

5 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.

6 Dhandho is Business Arbitrage Not only are Dhandho entrepreneurs not risk takers, they are arbitrage players. Town A Pop: 40, Miles Start with 1-2 Chairs. Charge a bit more. Expand as business grows Upside: Good; Downside: Minimal Eventually premium disappears. Heads I Win; Tails I Don t Lose Much Emerging Town C Pop: 200 to 1000 Town B Pop: 30,000

7 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.

8 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

9 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.

10 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.

11 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?

12 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)

13 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?

14 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.

15 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!

16 Publisher: John Wiley April 6, 2007 Pre-order your copy on Amazon today! Thank you!

17 Thank You. Mohnish Pabrai Managing Partner Pabrai Investment Funds Irvine, California, USA Tel