Adobe Systems, Inc.

Buy Price: $17.37

April Put Option Price: $.75

We have finished our preliminary research and found Adobe Systems, Inc. (“Adobe”) to be a compelling investment at its current valuation. Adobe is a consistent, diversified market leader in the software solutions space with excellent cash flows from operations, growth potential, and a healthy balance sheet. Based on the recent volatility and decrease in the markets over the past two weeks, we are committing 4% of our portfolio to Adobe. In addition we are selling four put options expiring in April to purchase an additional 6% stake at $15 a share (if ADBE shares decline to this level), which we feel would be a very compelling price based on our initial analysis. As shown on our Master Spreadsheet, we are reserving the required cash to make this additional 6% purchase. We will complete our analysis and update with a full entry in the near future.

Bottom Line:

Long 4%

April put options at $15 per share for an additional 6%

China Nepstar Chain Drugstore, Ltd.

Buy Price: $3.86

Overview: China Nepstar Chain Drugstore, Ltd. ("Nepstar") is the largest drug store chain in China with over 2,600 stores located mainly in eastern China's urban centers. Nepstar's story is one of consolidation. China's drug store industry is highly fragmented, with Nepstar accounting for only .5% of the country's drug store revenues. Instead, China's drug store industry is dominated by "mom and pop" stores, and local chains, similar to the United States before the wave of consolidation resulting in the Walgreens, Rite-Aid and CVS behemoths. Through consolidation, Nepstar will continue to develop its brand value, with the goal of becoming the "go-to" drug store (or one of them) for China's enormous urban population. It is also in the process of developing a higher-margin private label line of OTC medicine and other health products, which thus far is largely absent from the Chinese market.

Nepstar is a market leader with the financial capacity to take advantage of a highly fragmented but stable industry, without the use of any leverage. While we generally place little emphasis on macro trends because of our firm belief that we can't predict the future, we also cannot ignore China's increasing urbanization, enormous population, increasing use of western medicine, and high personal savings rate. Each of these macro factors certainly bode well for the nation's largest drug store chain.

While investing in emerging market companies certainly comes with higher risk than domestic companies, we find some comfort in the fact that Nepstar has a big-four auditor (KPMG), trades on the New York Stock Exchange and is owned 25% by Goldman Sachs (its IPO underwriter).

Management Effectiveness: Nepstar's return on invested capital (assets-unused cash/securities) of 19% in 2007, and roughly 13% annualized thus far in 2008 (probably more realistic given the costs of being a public company) are very good for a chain retailer. While not a perfect comparison, note that US retailers and drug stores operate with far less ROIC. In 2007, WMT had return on invested capital of roughly 8%, TGT less than 7%, CVS 6%. This solid ROIC can translate to a high ROE once Nepstar's cash is either returned to shareholders (see below) or used to develop/acquire stores.

Cash Flow: In 2007 and 2008, cash flow provided by operating activities was/is greater than net income.

Balance Sheet (so good its almost bad):As of September 30, 2008, Nepstar was holding $200M cash and $169M investment securities and had $0 long term liabilities. This cash is either slowly being returned to shareholders or used to acquire/develop shares. Nepstar pays a 3% dividend (modest given its cash position), and is in the middle of executing a $40M share buyback. In 2007 Nepstar articulated a target of 1,050 new stores in 2008.

Risks: Investing in Nepstar comes with several risks. The Chinese medicine industry is substantially regulated and a significant number of Nepstar's products are subject to price controls. Future regulation could collapse Nepstar's margins, or in the worst case, prohibit Nepstar from selling certain products. China's economy could fall into a long and protracted recession, pinching consumers and hurting Nepstar's revenues. In addition, the founder and CEO of Nepstar owns approximately 50% of the Company. While this position ensures that he has a vested interest in increasing shareholder value, his ownership could prevent the future acquisition of Nepstar or other transactions that return value to shareholders. We will be closely monitoring any related party transactions between the CEO and Nepstar. Note also that Goldman Sachs could decide to liquidate its position in Nepstar. If this were to occur it would put substantial pressure on Nepstar's stock price.

Valuation: Nepstar has a market cap of 438 with a P/B ratio of roughly 1. Its cash and investment securities give it an EV of roughly $59M. Based on 2007 earnings, EV/EBITDA* is roughly 2.5 (after discounting for minority interest), a very low multiple. Given recent market turmoil and the unpredictable nature of an emerging market stock, we believe that any estimates of an intrinsic value are academic at best so we won't venture a guess. Our opinion is that if rational pricing prevailed Nepstar would be valued substantially higher than an EV/EBITDA of 2.5.

*For those who are unfamiliar with the concept of Enterprise Value: EV is the value the market places on the "enterprise", independent of how that enterprise is capitalized (capitalization is subject to change - see the dividend and share buyback).

The Model:

The following model projects a conservative snapshot of the business in 3 years. We will assume that costs stay relatively stable, and that Nepstar will be able to acquire or create essentially as many stores as it is financially able to (which appears to be a realistic assumption given how fragmented the industry is). For purposes of this model we will ignore dividends and share buybacks. We will present a model using conservative assumptions and then for reference provide moderate and aggressive alternatives.

In 2007, Nepstar added roughly 556 stores. In 2008, Nepstar anticipated adding approximately 1,050 new stores (as of Nov. 2008 there were 665 new stores added in 2008).

New Stores: Nepstar estimated that it would spend approximately 42M in 2008 building and acquiring 1,050 stores, which equals roughly $40K per store. Three acquisitions thus far roughly confirm this number - Nepstar has purchased stores in 2007/2008 for roughly 55K per store. It would be expected that organic store openings require less than money than store acquisitions. When acquiring stores, Nepstar must pay a goodwill premium instead of merely purchasing the assets required to open a new store.

Nepstar has available capital of $369M to open/acquire stores. If we assume that Nepstar can spend $150M of this in the next three years acquiring stores - at a conservative projection of $50K per store - this would equal roughly 3,000 more stores over a three year period (Nepstar's 2008 goal was 1,050 stores). Nepstar also anticipates spending approximately $20M on two new distribution centers. Assuming these capital expenditures, and a conservative estimate of cash flows, less the capital required to open new stores, of roughly 20M per year (2007 operating cash flow equaled approximately 23M) for each of the three years, the cost of the additional store openings and the distribution centers would result in the use of approximately $110M. Nepstar would retain roughly 259M in cash/securities on its balance sheet (again we are not accounting for share buybacks and dividends).

Revenue/Earnings: In 2005 and 2006 Nepstar stores averaged annual revenue of approximately $165K per store. In 2007 this number was roughly $133K. According to management, the difference is explained by the rise in revenue after a store ages beyond three years - following Nepstar's IPO many of its stores are less than three years old. This model assumes a conservative $125K per store.

With an increase of 3,000 stores following 2008 Q3, Nepstar would have roughly 5,600 stores in three years. Our conservative estimate of revenue would be $700M.

Nepstar's operating margin was roughly 10% in 2007 and roughly 7% in the first three quarters of 2008 (a more realistic margin given the costs of being a public company). American drug stores generally have operating margins in the 6% range. A gross margin of 7% on 700M results in EBITDA of approximately 49M.

ROIC: As of September 30th Nepstar had $212M of invested capital. Following the $150M in store openings and acquisitions, and $20M for distribution centers, invested capital would equal $382M. At a tax rate of a 27% ROIC would be approximately 9.5%, a reasonable figure.

EV/EBITDA calculation: American drug stores (CVS, RAD, WAG), which have lower ROIC, lower margins and arguably less growth potential trade in today's market turmoil at roughly 7-9 EV/trailing EBITDA, and historically at a higher rate. We think a conservative EV/EBITDA ratio (without today's market dislocation) of Nepstar in three years is 8 (which would roughly equal a PE ratio, after subtracting the cash which is being slowly returned to shareholders or used in the business, of around 11). This ratio would result in the market pricing the value of Nepstar's business at approximately $400M. Combining the additional cash of $259M results in a market cap of approximately $660M, for a annual ROR of approximately 15.5% which beats the S&P 500s historical return by over 6%. We believe this conservative model leaves substantial room for better margins, greater cash flow, and perhaps most importantly, multiple expansion.

Alternative #2 (moderate):

Cost of additional stores: $45K (3,333 additional stores)
Revenue per store: $140K ($830M total)
Free cash flow per year: $25M ($275M cash at end of period)
Operating Margin: 8% ($66M EBITDA)
EV/EBITDA: 10
Mkt Cap: ($935M)
Annual ROR: roughly 30%

Alternative #3 (aggressive):

Cost of additional stores: $40K (3750 additional stores)
Revenue per store: $155K ($984M total)
Free cash flow per year: $30M ($290M cash at end of period)
Operating margin: 9% ($88M EBITDA)
EV/EBITDA: 12 (PE, after subtracting cash, of approximately 16.5)
Mkt Cap: ($1,346M)
Annual ROR: roughly 46%

Bottom Line:

Long 5%. We will continue to monitor Nepstar's expansion and margins.

Linn Energy, LLC

Buy Price: $15.77

History / Profile:

Linn Energy is an independent oil and gas company focused on the development and acquisition of long life properties in the United States. They operate in the following regions:

• Mid-Continent — core operating areas in the Texas Panhandle and Oklahoma; and
• Western — the Brea Olinda Field of the Los Angeles Basin in California.

The Financials:

Income Statement:

Linn Energy hedges nearly 100% of their production for up to five years, and all hedging income (losses) are reported on the quarterly and annual income statements, creating a jumbled mess when it comes to trying to figure out recognized income for a period. We try to analyze current earnings as going rate commodity prices plus/minus recognized gains/losses on hedges to arrive at the quarterly revenues, stripping out gains/losses on future hedges, under the assumption that we will pick those up in future periods. Linn operates under the tenet that constant cash flows are better the volatile ones. We tend to agree with this philosophy. Under our revenues model, we have calculated LINN recognized revenues for the past four quarters as:

Q1 - $195m unhedged, $185m hedged

Q2 - $255m unhedged, $230m hedged

Q3 - $240m unhedged, $218m hedged

Q4 est. - $150-$170m unhedged, $175-$201m hedged.

In the first three quarters, operating income was approximately 36%, 48%, and 39% of hedged revenues, respectively. We expect Q4 to be in the 30%-36% range, producing between $55-$75m of EBIT. Overall, with the hedging mechanisms in place, we believe that this income stream will definitely continue into the future, and grow substantially based on Linn’s management acumen, commodity price rebounds, capacity increases, or any combination thereof.

Cash Flow Statement:

Linn consistently produces positive operating cash flows based on realized income levels, and investments into future hedging devices. As an oil and natural gas company it requires substantial investment in fixed assets.

Linn’s current dividend policy is set at 62.5 cents per quarter or $2.52 per unit. Earnings at the partnership level are not taxed (Energy MLP), but this payout is taxed at the investor level (ordinary income) and totals approx. $290m a year. On income of $200m this is a bit worrisome, and we don’t foresee this level into the distant future, unless of course commodity prices rebound dramatically, and income rises sharply, which would be great news for LINN owners. However, I feel the dividend will eventually decrease to a more sustainable level closer to 100% payout ratio.

Balance Sheet:

See Valuation section below.

Overall Picture:

On the institutional side, Baupost Group, an investment vehicle run by the extraordinary value investor Seth Klarman has a substantial stake in LINN Energy (might actually be his largest holding) which based on his historic results bodes well for our decision to purchase. We don’t necessarily decide to invest just because a respected institution is “all-in” but it definitely makes us take a detailed look.

In the current market conditions, we see substantial value in energy stocks in general. Does anyone believe that commodities will remain at their current levels indefinitely? Where will they be in five years? Linn has taken most of the market uncertainty out of the equation. We can calculate a relatively stable revenue stream and earnings for five years. Where else can you find this in the current market?

Valuation:

P/E Valuation: $3.3B or $28.60 per share

We estimate total year realized income of approx. $200m in FY 2008 and a conservative 5% growth rate, a CAPM discount rate of approximately 11% produces an earnings multiplier of 16.6 (keep in mind, we are calculating based on realized income only, which is very different than GAAP earnings) and a total enterprise valuation of $3.3B, which is a 74% premium to what it is trading at today.

Book Value Valuation: N/A

As of Sep. 30, Linn had assets of $4.0B and liabilities of $1.9B, therefore a book value of approximately $2.1B a slight premium to its market cap ($1.9B). Most ($3.6B) is tied up on PP&E which makes sense given the industry. Due to the subjectivity in valuation of the PP&E , we do not have an interest in speculating on the book value multiple it should be trading at (as it would take expertise on the side of valuing natural resources). We are intrigued by the company trading at below book value, but do not weigh this metric as heavily as cash flows or earnings.

Risks:

With a new democratic president in office, there is a risk that the tax-free status of energy partnerships will disappear. This could have a major effect on the income of LINN Energy (decreasing it by 40%). In addition, commodity prices have been highly volatile, and could continue to be highly volatile in the future.

The Bottom Line:

Long 5%

We are allocating 5% of our portfolio to purchasing LINN Energy. We will continue to monitor going forward.

Greenlight Capital Re, Ltd.

Buy Price: $12.90

Overview:

At current prices, Greenlight Capital Re ("Greenlight") provides an excellent opportunity to piggy-back off of the future investment performance of one of the superior value-oriented money managers of our time, David Einhorn, founder of the hedge fund Greenlight Capital.

Greenlight, founded in 2004 by Einhorn (who owns 10% of the company) operates as follows: Einhorn has hand-picked a few reinsurance veterans to head up a Cayman's based underwriter which writes casualty and property reinsurance contracts through a network of brokers. Unlike many (re)insurers, Greenlight focuses its underwriting on, and management is compensated upon, multi-year underwriting performance rather than sheer volume. The goal is long term underwriting profit (premiums collected less claims paid out). Thus far, management has been clear that it will not write policies if not profitable, it will instead sit on its hands and rely on investment performance. It should be noted that there have been and will be times when writing reinsurance policies by themselves (absent investment performance) is a losing business. The price of insuring risk fluctuates. Insurance premiums collected are then managed by Einhorn through DME Advisors (the management company of Greenlight Capital, the hedge fund). Note that Greenlight will pay fees and expenses to DME Advisors (the classic 2 and 20) just like other hedge fund investors.

The Company then profits in two ways: (1) the net difference between premiums paid for reinsurance contracts written, (2) returns on the investment of these premiums. This model may sound familiar to stock market followers - Warren Buffet has invested insurance premiums, or "float" for years. In addition to owning primary insurers (e.g., GEICO), Berkshire Hathaway also owns General Re, the world's third largest reinsurer. Insurance premiums allow an investor to essentially borrow money via an interest-free loan and invest this money. Sometimes, the (re)insurer must return all of the money, sometimes more of the money, and if contracts are written by keen actuaries with an eye towards underwriting profit, slightly less of the money.

David Einhorn:

Few investors have as stellar a performance record as David Einhorn. Starting with $1M under management in 1996 after a stint as an investment banker, Einhorn's fund has delivered anual returns of over 24%, after fees and expenses. Even more astonishing is that these returns have come without the use of leverage. Einhorn is a classic long/short stock picker, relying on relentless due diligence. As he puts it, he invests long in 9s or 10s, and shorts 1s and 2s. The stability of his investment performance (inherently hedged to overall market risk through the use of a long/short strategy) has allowed Greenlight to maintain an A- (excellent) rating from A.M. Best. We believe that Einhorn will continue to produce market beating performances (not constantly year-in and year-out but over a longer time horizon), not just because of his past performance record but because he and his team devote themselves to uncovering misunderstood situations and show an analytical ability few can match. These investment returns combined with underwriting profit will allow for compound growth that will likely substantially outperform the market for years to come.

Taxes:

In addition to the compound investment returns that result from underwriting premiums, Greenlight also comes with a built in tax advantage. As a Cayman Island's corporation, Greenlight doesn't pay corporate income tax, further allowing for compound growth in investment income. This treatment comes with some risk (see below).

Valuation:

Traditional valuation ratios (PE, PEG, EV/EBITDA) are largely irrelevant when discussing a reinsurer such as Greenlight. Profit will fluctuate wildly from year to year based on investment returns.

Greenlight's goal is to instead increase tangible book over time at a market beating rate. Assets will consist of investments managed by Einhorn and cash available to pay claims. In most years, we anticipate that Greenlight will trade at a modest premium to book value (reflecting Einhorn's superior investment performance). Greenlight currently trades at a slight discount to book value, which we believe presents a compelling investment opportunity. If Greenlight begins to trade at a premium to book value that we believe is unsustainable we will consider selling our position.

At a given moment, Greenlight will have cash roughly equal to its outstanding liabilities (which consist of an actuarial estimate of claims), and thus its book value will roughly equal the amount of money invested with Einhorn.

Risks:

Greenlight comes with several risks, including (1) underwriting risks, (2) investment risks, and (3) organizational/tax risks. Underwriting, particularly in the property and casualty space comes with inherent risks beyond the control of management, including the occurrence of natural disasters. While we believe Einhorn's investment performance will beat the market over a long period of time, Greenlight's investments are subject at any time to market dislocations or even mistakes of Einhorn. Greenlight could also lose its current tax status if deemed to be a passive foreign investment under US law. If so, stockholders would be taxed based upon on corporate level earnings at their ordinary income rate. Greenlight will need to be conscientious about being a reinsurer first, and a hedge fund investor second.

The Bottom Line:

Long 10%

We are allocating 10% of our portfolio to purchasing Greenlight. We will continue to monitor price to book value going forward.