Wednesday, September 12, 2007

Moody Brothers

Some of the most high profile value investors have been hit hard by the recent turmoil in the credit markets. Bill Miller and Wally Weitz have seen their holdings in homebuilders and mortgage originator Countrywide Financial (NYSE: CFC) suffer massive losses.

It doesn’t stop there. Great franchises suspected of being remotely exposed to the subprime fiasco in one way or another have seen their shares pummeled over the past few months. Citigroup (NYSE: C), Lehman Brothers (NYSE: LEH) and Moody’s (NYSE: MCO) are a few that come to mind.

What if Mr. Bernanke doesn’t cut rates? What if home prices plummet? What if the U.S. consumer is tapped out? People asking these questions are also throwing around the R word - you know, a Recession.

Against this backdrop, the Millers of the world are sticking to their guns. In a recent letter to shareholders, Miller contends that he would be a buyer of homebuilders and Countrywide if they were not already in his portfolio. To form, as two large shareholders in Countrywide were unloading shares in August, Legg Mason increased its position in the firm. Then there was Bank of America’s (NYSE: BAC) $2 billion injection into Countrywide which it can turn into an equity stake convertible at $18. And yes, amid this mayhem, our friend Mr. Buffett took a new position in Bank of America and continued to increase his exposure to banks. Mr. Lampert also jumped in and bought a stake in Citi.

A bear trap? Hardly. Is there more turmoil ahead? No doubt. But it is precisely this kind of uncertainty which creates long term opportunity. There is no question that Moody's business will be affected as appetite for fancy loan structures has all but disappeared. But the company's long term prospects will not diminish because of recent scrutiny of its role in the creation of CDOs - that would be a collaterlaized debt obligation. Meanwhile its stock has declined more than 35% from peak. Some of the financials I have mentioned above are trading at extremely attractive multiples and provide Treasury like yields close to 5% to boot. Lehman, as profiled in Barron's recently, could be a Goldman Sachs (NYSE: GS) in the making and trades at only 1.5 times book value. Even Countrywide is worth a look. The company has survived through down cycles before and has managed to diversify its business to include banking. Smaller rivals are exiting the mortgage business altogether. The company should emerge as a stronger player once the market stabilizes. It has ample resources at its disposal to navigate through the credit crunch and is trading below book value.

Moody’s is now predicting that housing’s woes will not subside anytime before 2009. That may seem light years away but if your time horizon is more like 5 to 10 years, this is the time to take advantage of Mr. Market’s generosity and start building a position in some fantastic businesses such as Moody’s and Lehman.

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