Berkshire Hathaway, Inc. (BRK/B)

Buy Price: $69.36

This morning we decided to purchase 144 shares or Berkshire Hathaway Class B shares. After the recent spilt we decided, like many others, it was time to enter the position as a core holding for our portfolio. Our short term outlook is that the stock split will cause short term price appreciation and volatility. Berkshire is currently at the lower end of historical price to book valuation and provides strong long term return possibilities. The diversification of the business holdings creates a margin of safety in the current market and economic conditions, more so than a lot of more concentrated businesses. We firmly believe in Berkshire management, and are excited about holding Berkshire for years to come.

Petmed Express, Inc.

Overview: On 12/21 we purchased 415 shares of Petmed Express, Inc. (ticker symbol: PETS) and are looking to purchase more in the event of any price weakness.

Investment Thesis: PETS operates an online and telephone pharmacy for prescription and non-prescription pet medicine, mostly for dogs, cats and horses, and is the market leader in the roughly $3.6B pet medicine market. PETS is a simple business and we have a simple investment thesis: We believe we've found an extremely capital light and scalable business with secular tailwinds and sustainable competitive advantages (a developing brand, a positive consumer experience and low prices) trading at a very reasonable valuation.

Business; Business Advantages: Despite PETS recent successes, most pet medicine today (roughly 80%) is sold through a veterinarian for marked up prices which reflect an expensive middleman. PETS is taking square aim at this large market. We, along with PETS management, believe that the long-term internet retail trend could very well affect the pet medicine market as much as the book or music markets. Setting aside emergency treatments, pet medicine is a product that translates easily to online sales - there isn't a consumer need for a unique or local experience and the product is small, light and easily shipped across long distances. Pet medicine is manufactured and sold by national pharmaceutical companies that have an interest in the greater consumption and consumer goodwill which results from lower retail prices. While the major pharmaceutical manufacturers have declined to sell directly to marketing companies such as PETS and instead sell indirectly to PETS through third party suppliers, PETS is working to develop direct supply channels with pharmaceutical companies for some widely purchased medicines. If successful, PETS could offer these medicines at even greater discounts which would further improve their competitive position. In addition to the broad-based internet consumption trend, we are attracted to the pet medicine business because it's anything but faddish, is recession resistant and is lightly regulated (unlike human medicine). We think it a foregone conclusion that spending on pet medicine will increase over time. We believe PETS is well positioned to participate in any increase in the broader pet medicine market while also gaining market share. In the grips of recession, the company attracted 802,000 new customers in 2009 vs. 710,000 in 2008.

Financials: The competitive advantages discussed above are demonstrated in PETS ten-year financials. In 2000, PETS generated $14.7M in revenue and lost $1.8M. In 2002, the company's first profitable year, PETS generated $32M in revenue, and $.8M in net income. In 2009, the company generated $219.4M in revenue and $23M in net income. PETS is one of those rare, scalable businesses where the bottom line grows quicker than the top line. The company's five-year average revenue growth rate is 18.5%, and five-year average net income growth rate is 31.4%. This difference can be explained by the operating leverage and cash flows an online retail operation can generate. As a very capital-light business, cash which doesn't need to be reinvested in the business can be used to repurchase the company's shares. PETS spent $11.6M in 2008 and $18.5M in 2009 in share repurchases. In 2009, the company began a quarterly dividend, rare for a young, high-growth company. Often a company's long-term competitive advantages can be seen in its annual return on assets and return on equity. PETS has maintained return on assets in the high 20s, and returns on equity in the low 30s over the last five years while offering consumers low prices for their pet medicine, an impressive feat that demonstrates the strength of this business.

Valuation: We think that PETS current price doesn't accurately reflect PETS growth prospects and business strengths. PETS trades at roughly 14.5x our estimate of fiscal year 2009 earnings, less on an enterprise value basis due to the more than $50M in excess cash on the company's balance sheet and its lack of debt. We think that it likely that both per share earnings and the stock's earnings multiple expand over the medium to long term, resulting in market-beating returns for this investment. Compare this multiple to other market-leading internet retailers: Amazon (AMZN) trades at roughly 74x trailing earnings, and Blue Nile Inc., the diamond retailer (NILE), trades at roughly 80x trailing earnings. Based on earnings growth and return on assets alone - admittedly a simplistic criteria - PETS is arguably a stronger company than either. (Note that we are not suggesting that PETS rivals Amazon in business strength or competitive advantages – we simply think we’re getting a much better bargain with PETS.)

The Amazon/Walmart Risk: We think that the market’s subdued enthusiasm for PETS can be largely attributed to the sense that the company's market position and continued growth is susceptible to a bigger, stronger competitor’s foray into the online pet medicine market, such as Amazon or Walmart. We think that it far more likely that a larger retailer would choose to purchase PETS at a hefty price given its growing customer base and customer goodwill. We also believe that the current thinking about Amazon – that it will become the Walmart of the internet, squeezing out niche online retailers – is an analogy to brick and mortar retail that doesn’t quite translate. Switching web pages is a much different experience than physically visiting many retail stores to purchase the goods one could buy at the lowest prices in a big box retailer. Finally, we think that purchasing pet medicine through PETS is a sticky user experience. As the market leader with the lowest prices and a quick and easy platform for repeat purchases, we find it unlikely that pet owners will actively shop around for pet medicine once plugged into the PETS system. Nevertheless, given PETS recent financial successes, we have little doubt that the online pet medicine business will attract competition and view the success of this competition as the single largest risk to this investment. We see the success of the company's advertising and the steps the company takes to create an increasingly efficient and enjoyable user experience as the two most critical components to staving off competition. Given the low capital requirements of the business, we wouldn't mind seeing an increase in advertising spending and website development at the expense of short term earnings.

PetMed Express Inc.

Yesterday we purchased 415 shares of PetMed Express Inc. (ticker symbol: PETS) at $18.09 per share for $7,507.35, less commissions. We will look to purchase more shares in the event the stock declines over the next few months. Please check back for a full write up of this investment.

WSP Holdings, Ltd.

Sell Price: $3.60

On Wednesday (11/26) we sold our 1,450 shares of WSP Holdings Ltd. (WH) for $3.60 per share. Our initial purchase was at $3.48 per share in May, and we received a $.45 per share special dividend in late June. Including the dividend, our IRR on this investment was 32.94%. We feel fortunate to have made a profit. During our holding period,WSP's business has deteriorated substantially, resulting in a recent quarterly loss. The company is facing large tariffs in the North American market, downward pricing pressure resulting from a glut of supply in the asian markets, and general declining demand. Due to rapid expansion and facility construction, the company's short term debt has increased substantially and is sitting at $500M as of September 30th. While we don't question the potential upside of an investment in WSP at current prices, we feel that there is far too much uncertainty facing this business to justify our continued investment, especially where we can exit with a modest profit.

Ark Restauraunts Corp.

Buy Price: $13.72

Overview:

On 10/29 and 10/30, after following the stock and its price movement for a number of months, we were happy to purchase 730 shares of Ark Restaurants Corp. (ticker symbol: ARKR) at an average cost of $13.72 per share.

Company Description:

Ark is a the owner or operator of roughly 50 restaurants, night clubs, bakeries and fast food facilities in the United States, primarily New York City, Las Vegas, Washington D.C., Boston, Florida and other locations in the northeast. Ark's restaurants are built around individual concepts and designed to cater to local markets, with exceptions being the America, Sequoia, Gonzalez y Gonzalez and Gallagher's Steakhouse concepts, which Ark owns two of each. Most restaurants are owned directly by Ark, although the company periodically enters into management arrangements with outside investors where the investors fund the building of the restaurant and Ark serves as manager, earning a percentage of revenues. Ark both purchases existing restaurants as well as designs and builds new restaurants depending on market opportunities. In development, management (i.e., CEO Michael Weinstein) targets tourist destinations with high foot traffic or other notable destination-type locations with robust economics (e.g., Bryant park in New York City behind the New York Public Library, the center of Union Station in Washington D.C. or Las Vegas casinos). Management spends considerable energy developing the "look and feel" of its restaurants, and to a certain extent atmosphere is more of a priority than food quality (like most successful restaurants). The company builds strong relationships with landlords and enters into long-term leases at rates which facilitate strong cash flow.

Management/Operations:

Ark has been in existence since 1983, when former investment banker, Michael Weinstein, decided to switch careers to restaurant ownership and management. Weinstein has a reputation for prudent capital allocation and business integrity as both a fiduciary to shareholders and an employer. Conference calls are quite enjoyable to listen to because of Weinstein's uncommon and refreshing candidness. Weinstein and his staff seek out locations for restaurants which will maintain sustainable economics and accretive cash flow as opposed to mindless revenue growth. Note that the company had a poor experience a number of years ago with several failed restaurants in suburban New Jersey, an experience which Weinstein and the company have learned from in selecting ongoing restaurant concepts and locations.

The company generally funds restaurant acquisitions and development from operating cash flow instead of additional stock sales or borrowing, and either distributes excess cash to shareholders or repurchases stock when there doesn't appear to be acceptable opportunities for growth. Shareholders received a $3.00 per share special dividend in 2007, a $1.00 per share special dividend in October of this year, and regular dividends when business operations support them. In March 2008, the board approved a stock repurchase program under which up to 500,000 shares of common stock may be acquired over a two-year period (no small amount given that the company only has about 3.5M shares outstanding).

While Ark isn't a traditional "wide-moat" business or in an industry we are particularly fond of (restaurants largely come and go), we think management's approach has given Ark a sustainable competitive advantage. The company's return on assets dwarfs other publicly traded restaurant companies (15.04% in 2004, 14.29% in 2005, 10.52% in 2006, 24.95% in 2007, 13.14% in 2008). For example, Brinker International, Inc. (EAT), Cheesecake Factory, Inc. (CAKE) and Darden Restaurants, In. (DRI) regularly achieve return on assets in the mid to high single digits.

In the last five years, management has achieved return on shareholder's equity in the high teens to mid 20s without the use of significant debt. While we believe Ark's casino-based concepts are struggling in the current economic environment, we worry very little about the stability and future cash flows of the company's urban locations - these restaurants are in premium locations with robust economics which simply can't be replicated in suburban strip-malls. For example, the company is in the process of opening a restaurant on the 9th floor of the Museum of Arts and Design at Columbus Circle in NYC, which will overlook Central Park. The term of the lease is 16 years, with two 5 year renewal options. While the lease commitment is substantial, we're confident that management can create a winning concept at this premium location and the long-term lease will end up being a substantial asset. We also don't question the long term viability of Las Vegas as a magnet for consumption.

Valuation:

At our purchase price of $13.72 per share, Ark's market cap is roughly $47.8 million. After distributing $3.5 million to shareholders as a special dividend, Ark will have excess working capital of around $5.7 million, and no long term debt. Assuming $1 million is needed for general working capital purposes, enterprise value is roughly $43.2 million.

Fiscal year 2007 and 2008 EBITDA was roughly 12.3 and 11 million respectively, for an EV/EBITDA multiple of 3.5x or 3.9x. Fiscal year 2007 and 2008 net income from continuing operations was $7.9 and $6.9 million respectively, for a EV/NI multiple of 5.4x and 6.2x. (We believe NI will be approximately $3.0 million for the fiscal year ended September 30, 2009, when released, for an EV/NI multiple of 14.4x) For comparison purposes, DRI and CAKE currently trade at EV/NI multiples of 2008 earnings in the high-teens, and most likely will be in the mid to high 20's using TTM figures. Both EBITDA and net income will be lower this year than 2008 given the tough economic environment (especially in Vegas), although Ark will report positive net income and, according to management, every one of its restaurants is cash flow positive.

We cannot predict the length of the current economic downturn, and aren't sure what to expect in the next couple of years, but believe operations and earnings will continue to improve, and begin to normalize if not grow. As this occurs, Ark's stock price will likely expand and reflect a multiple of earnings similar to its historical average (around 15x). Until this happens, we'll gladly collect the stock's $.25 quarterly dividend which is more than supported by current cash flows (a roughly 7.25% yield). While we can't be sure what Ark's theoretical intrinsic value is (we prefer the "know it when you see it" approach to value investing), we believe the stock's current price, given the company's debt-free balance sheet and shareholder-friendly management, provides a sufficient margin of safety and attractive upside potential to justify our investment.

Note about Liquidity and Ownership:

Ark is a micro-cap stock with very little liquidity and a wide bid-ask spread on any given day. One shouldn't invest in Ark without a medium to long term investment horizon, an approach we're happy to take. The company is entirely off wall-street's radar, which can result in inefficient pricing, but which can also make value realization a patience-trying experience. The company's float is very small, only about 1.8m shares. CEO Weinstein owns roughly 30% of the company, so he exercises substantial control over the company's activities, but also eats his own cooking...

China Nepstar Chain Drugstores, Ltd. Calls

On November 6th, we sold thirteen China Nepstar 7.50 calls which expire in March for $75 each. If exercised, our effective sales price of the 1,300 shares will be $8.25 per share, for a gain of roughly 214% on our purchase price before commissions. This return is calculated before taking into account this year's $.35 dividend, and the special dividend of $1.50 which will be paid around December 31st (which raises our return to roughly 262% in the aggregate, before commissions, not taking into account time differences in payment of the dividend, sale of the calls and sale of the stock). Note that the stock is now ex-dividend, and the price currently reflects the December special dividend.

Selling these options and our accrual of dividends has given us the ability to recoup approximately 67% of our initial investment in a short amount of time. The drastic multiple expansion and stock appreciation has occurred with relatively lackluster earnings reports and only modest expansion in Nepstar's business. $7.50 a share represents a roughly 20x EV/trailing EBITDA multiple - far above the 8x target we had discussed in our initial write-up. We have decided to sell the options to give ourselves time to see if the business fundamentals will catch up to the current valuation, and support continued investment. If this is not the case we will be very happy with our exit price with a holding period of just over one year.

Ark Restauraunts Corp. (Update)

On Friday, following a large drop in price in ARKR we decided to purchase an additional 380 shares at $13.18 per share. We will post a full write-up for this investment shortly.