HOW CONCENTRATED SHOULD YOU BE?

HOW CONCENTRATED SHOULD YOU BE?

RE-EXAMINING THE BIG BET THEORY

VALUE INVESTING CONGRESS WESTMay 8, 2007

PRESENTED BY:

Zeke AshtonCentaur Capital Partners

Some Small Ideas are Worth Having

• Value investing literature is heavy with the concept of concentration, with which we generally agree. However, we believe that running super-concentrated portfolios requires a combination of manager and capital base attributes that only a select 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 each idea 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 the bottom of the portfolio has improved both our returns and the reliability of those returns.

There are Many Ways to Value Investor Heaven

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

• Some idea types justify a significant deployment of capital while others 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 CowsOverlooked Small Caps Oddball CompaniesFallen Growth Angels Sum-of-the-PartsGARP (Growth At Reasonable Price) Activist OpportunitiesSpin-offs Post-bankruptcies

Idea #1: Hennessy Advisors (HNNA)

• Asset manager that offers a family of six mutual funds using themechanical formulas developed by James O’Shaughnessy in his book What Works on Wall 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 O’Shaughnessy 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 Management’s 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 $6.75 million (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 market cap.

Idea #1: Hennessy Advisors (HNNA)

• Hennessy Funds have very competitive returns and very low costs, with management 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 or analysts to pay.

• Founder and CEO Neil Hennessy takes a modest salary and an annual bonus of 10% of pre-tax profit. We believe this is a fair arrangement for shareholders.

• Hennessy’s 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 our estimated range of 2007 free cash flow of $5.5 - $6 million.

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

Idea #2: Collector’s Universe (CLCT)

• Collector’s Universe is a leading provider of authentication and grading services 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 an independent third party expert to certify the quality and authenticity of high-value specialized merchandise.

• The company may become a very long-term growth play on the increase in sales of “sight unseen” channels for high dollar collectibles and memorabilia, 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 market information to dealers and collectors using the proprietary and potentially valuable information gathered via its authentication and certification businesses. This adds potential for both recurring subscription revenue and advertising revenue.

Idea #2: Collector’s Universe (CLCT)

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

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

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

• The sports card business is modestly FCF positive (~$1 million per year, but the stamp, autograph, and currency businesses are not profitable. The diamond and gem business is currently unprofitable and isn’t 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 andenhances shareholder, or they don’t work and management discontinues investing in them and monetizes the assets. The true earnings power of the core business would then be revealed.

Idea #3: Stewart Information Services

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

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

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

• Stewart reported revenue of $2.47 billion in 2006 and $2.4 billion in 2005.

• Average FCF per year for years 2001-2005 was $118.7 million. The company 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 lower margins and higher cap-ex on technology spending in 2006.

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

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

Idea#4: Ag Growth

• Ag Growth is a highly profitable and well-run manufacturer of agricultural equipment.

• The company has a dominant market share in its specialized niche of grain 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 equipment that 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 high quality competitors at accretive prices.

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

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 $C282 million. 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 EBITDA for Hansen, which is a growing business.

• At approximately 10X FCF and yield of 7.5%, Ag Growth is a cheap and safe “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 tax treatment.

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

Why Aren’t These Bigger Ideas?

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

• Collector’s Universe is a probability bet that appears to offer an asymmetrical risk / reward profile. The downside appears to be protected, and the stock appears to offer some potentially very valuable “free call options”. However, it is hard to quantify value 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 like STC 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 reasonable price with strong winds at its back. Illiquidity is the primary concern. We sized it at 3%.

Portfolios of Noted Value Investors

Some noted value mutual fund managers and their portfolios:

FUND IDEAS % TOP 10 % TOPSequoia 22 77.2% 27.0%Tilson Focus 26 74.6% 14.6%Clipper 20 73.0% 9.7%Fairholme 18 69.7% 16.8%Oakmark Select 20 62.0% 15.0%Legg Mason Growth Trust 25 54.4% 6.9%Longleaf Partner 23 53.2% 9.4%Weitz Value 33 49.7% 7.4%Legg Mason Value Trust 41 45.0% 5.2%Tweedy Brown Value 41 44.0% 5.6%John Hancock Classic 41 38.9% 4.8%Third Avenue Value 100+ 37.5% 7.0%

*Tilson Dividend Fund 25 52.1% 6.5%

Common Value Investor Portfolio Models

There are several common “portfolio models” used by successful value investors that we have come across:

Ultra-Concentrated Portfolio Model

• Definition - Fewer than 10 stocks with large position sizes routinely 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 there may be one or two larger positions, and a handful of smaller positions for a total of 12-20 ideas.

• Practitioners: Mohnish Pabrai, Clipper,

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, and there are fewer sub-5% positions. Total of 20-30 ideas.

• Practitioners: Tilson Focus, Fairholme, Sequoia, OakmarkSelect

The Centaur Portfolio Model

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

compelling valuation with significant margin of safety.

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

2.5% – 4.0% Solid or even excellent idea with one or more minor risk factors, which might relate to business or industry quality, valuation, liquidity, political risk, or level of our conviction and ability to completely understand all aspects of the business.

0% - 2.5% Interesting and sometimes compelling idea that may be very illiquid, may be a probability bet with a favorable asymetrical reward to risk ratio, or may simply be a low quality business that is very cheap relative on a NNWC or price / tangible book value basis.

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 we

believe risk is very low. 2-3% Standard Excellent Idea, usually will have no more

than two or three shorts of this size. 1-2% Solid or even excellent short idea with one or more

but certain risk factors to the short thesis might be present, such as high short interest, low float, low market cap, etc.

0% - 1% Generally reserved for short ideas utilizing a put option instead of common, where the probability of a good outcome might be low but the magnitude of a positive outcome might be significant to our performance.

The Reliability Payoff

• It’s not about reducing volatility, it’s about increasing reliability.• We want enough ideas to ensure that our sample size is big

enough 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 improves reliability.

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 comparison, all “worsts” are reported net of management fees but before incentive fees. Annualized returns from inception for our longest tenured fund (Centaur Value Fund) from August 1, 2002 – March 31, 2007 net of management fee but before incentive fee were approximately 23%.

Maxims Regarding Position Size

• The goal for all investors should be to get the most value out of your best ideas without risking significant capital loss if you are wrong.

• Concentration isn’t a constant – it is idea and environment dependent.

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

• The more concentrated you are, the more rigorous you have to be 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 is

required to protect skillful investors from the capriciousness of luck and unexpected bad outcomes.

• If you can’t sleep well at night, either you don’t own the right stocks or you are running too concentrated a portfolio.

Practical Questions to Ask Yourself

• What type of portfolio is consistent with your portfolio and personal 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 certain risk profile?

• How many ideas can you process and maintain? What kind of ideas 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? A team is going to generate more ideas than a solo practitioner.

Final Thoughts

“Confronted with the challenge to distill the secret of sound investment into 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 as applicable to portfolio construction as it is to individual investment selection.