Value Investing - U.S.

Why Value Investing?
Value investing works because it is founded on the notion of buying something for less than it is worth. The value investor has the best of both worlds: upside potential and the comfort of owning a business with a margin of safety. Value investing has withstood the test of time. Great investors over a long period of time have earned substantial returns by employing a consistent investment discipline. One of the greatest attributes of successful value investors is buying bargains when the market refuses to focus on them.

U.S. Value Investing
For nearly a quarter century, Gabelli Asset Management has earned superior returns for its clients through a focus on value investing. We invest primarily in the equity securities of cash generating, franchise companies, selling in the public market at a significant discount to our appraisal of their Private Market Value. We define Private Market Value (PMV) as the value an informed industrialist would pay to purchase assets with similar characteristics. We measure PMV by scrutinizing on- and off-balance sheet assets and liabilities and free cash flow. As a reference check, we examine valuations and transactions in the public domain. Our investment objective is to achieve an annual return of 10% above inflation for our clients.

Columbia Business School, the home of Graham & Dodd value investing, credits Mario Gabelli for inventing the notion of Private Market Value, and for coining the term "catalyst" to apply to events that surface value.

Our investment methodology has succinctly been defined by an observer as:

Graham & Dodd + Warren Buffett = GABELLI

Our investment process centers on the application of principles first articulated in 1934 by the founders of modern securities analysis, Benjamin Graham and David Dodd, in their seminal work Security Analysis (1934). To this, we add what Warren Buffett contributed to the field of investing: the notion of valuing a business's franchise and taking a substantial stake in portfolio companies. We then blend two unique elements of the investment process: assessing a company's private market value (PMV) and identifying a catalyst to surface these underlying values. We begin the process by focusing on companies that dominate their markets and demonstrate an ability to generate substantial free cash flow. Our goal is to identify companies in the public market that are selling at discounts to their intrinsic or private market value. A catalyst may take many forms and can be an industry or company specific event. Catalysts can be a regulatory change, industry consolidation, a repurchase of shares, a sale or spin-off of a division, or a change in management.

Our approach to investing is research driven. Our valuation methodology has a three pronged approach: free cash flow (earnings before interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. We rely on internal research. Our analysts narrow the list of potential investment candidates by reviewing publicly available materials such as annual and quarterly reports and proxy statements. Each analyst develops an operational understanding of his or her industry, effectively becoming an expert in that industry. The analysts sharpen this expertise by continually visiting companies and their senior managements, and speaking to suppliers, competitors and customers. The objective of this process is to identify companies that trade at a significant discount to their intrinsic or private market value.

We select stocks that have the potential to provide a 50% return over two years. Our sell decision is made for us when the securities are selling in the public market at or near our estimate of their private market value or if the catalyst we expected to happen fails to materialize.

What areas do we see as having value?
Let us illustrate our approach to value investing by using a few recent examples. One area is what we call "takeout" utilities. Most of the small and medium size utilities (with a million customers or fewer) are destined to be acquired by bigger companies. Especially attractive are small companies in mature markets that are reasonably priced. They are natural targets for bigger companies which can afford to pay a premium and still make the acquisition accretive to earnings. One such company is Eastern Enterprises (EFU - NYSE). This is a company headed by Woody Ives, who we knew since his days at General Cinema. Woody was patient enough to walk us through his business model and valuation process for acquiring other companies, for example, Colonial Gas. When the prices became too rich for EFU to expand through acquisitions, they placed the company on the auction block for the benefit of all shareholders. Our clients were richly rewarded by the $64 per share takeover proposal from KeySpan Corp.

A catalyst can take many forms. One of our most successful investments over the years has been Ralston Purina (RAL - NYSE). There are a number of catalysts currently in place including the spin-off of the Eveready Battery company. This is a corporation run by financially savvy management who know how to structure transactions for the benefit of all shareholders.

Another example, Telephone & Data Systems Inc. (TDS - ASE) is a diversified telecommunications company with established cellular and local telephone operations and a developing personal communications services ("PCS") business. TDS owns 81.1% of United States Cellular Corp. (USM - ASE) and 82.4% of Aerial Communications (AERL - OTC), a PCS subsidiary. Our research valuation methodology focused on the company's strong earnings, cash flow and a Private Market Value FIVE TIMES over our purchase price of $40. In addition, there were several catalysts we identified. One became reality when VoiceStream Wireless (VSTR - OTC) announced the $3.3 billion acquisition of Aerial.

Chris Craft Industries, Inc. (CCN - NYSE) is the owner of 10 television stations, eight of which are independent stations in Top 25 markets including the crown jewels of New York, Los Angeles, and San Francisco. In addition, the company has $1.5 billion in cash and marketable securities. A powerful catalyst unfolded when the Federal Communications Commission ruled in August 1999 that television operators can now own two television stations in a market, also known as a "duopoly". Chris Craft, a major beneficiary of this ruling, is currently exploring ways to unlock its values as consolidation drives television station prices higher.

In summary, "value plus a catalyst" is a winning formula for generating superior returns in any market environment.

For information, call: 1-800-GABELLI (422-3554)
One Corporate Center, Rye, New York 10580