August 20, 2007

Resources America

Many companies fit the bill, but we focused on one we have owned for years, Resource America, a rapidly growing company that manages assets across a broad range of categories and earns attractive spreads on structured finance pools. Not surprisingly, the stock has been cut in half in recent months. While it was no fun seeing one of our holdings decline so quickly, we smelled opportunity, redid our analysis, spoke with management and became convinced that the market is wrong on Resource America, incorrectly assessing its potential liabilities. We have been adding aggressively to the position such that it is now among our largest.

Resource America consists of four business groups. The area that most concerns investors, Resource Financial Fund Management, manages pools of collateralised obligations in the trust preferred, asset-backed securities and leveraged loan markets. Assets under management are nearly $17bn, up from $10.5bn one year ago. RFFM earns management fees of 25-50 basis points on these pools, and structuring fees.

The key to getting comfortable with this business is understanding that Resource America, unlike many of its peers (which are now encountering distress), maintained a discipline when setting up these pools by moving them off Resource America’s balance sheet and financing them with non-recourse debt. As a result, it is the debt-holders, not Resource America, who bear nearly all of the default risk. Although this model resulted in less net interest spread for the company during the boom times, it also meant that the recent jump in defaults and drying up of liquidity had not affected Resource America’s business materially. This is contrary to what the stock price indicates – hence the opportunity.

A final reason we have so much confidence in this investment is our long-term relationship with Jonathan Cohen, Resource America chief executive, whom we believe is a strong operating manager, very risk-averse, trustworthy and shareholder oriented. Resource America’s management and board share our belief that the stock is significantly undervalued – we think its intrinsic value approaches $30 a share – and just announced a $50m share buyback, which at current prices represents more than 15 per cent of the company.

The market in recent weeks has been a wild ride, and I’d bet my last dollar it’s not over. Keep a close eye on stocks you like and be ready to act with conviction when Mr Market opens the door to opportunity – it may not stay open long.

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