Dhandho! Low Risk + High Uncertainty = High Rewards Mohnish Pabrai Managing Partner
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.
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!
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.
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.
Dhandho is Business Arbitrage Not only are Dhandho entrepreneurs not risk takers, they are arbitrage players. Town A Pop: 40,000 30 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
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.
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
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.
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.
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?
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)
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?
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.
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!
Publisher: John Wiley April 6, 2007 Pre-order your copy on Amazon today! Thank you!
Thank You. Mohnish Pabrai Managing Partner Pabrai Investment Funds Irvine, California, USA mpabrai@pabraifunds.com Tel. +1949.275.5652