10 Questions With Yacktman Funds' Donald Yacktman: Tyco Anyone?

OK, here are a few hot picks for you: Tyco (TYC), Qwest(Q) and Liberty Media(L) -- yes, that Tyco, that Qwest and that Liberty Media.

Are you still there?

These are a few of the picks of Donald Yacktman, manager of the (YAFFX)Yacktman Focus fund. This is a man who has actually made money this year: The fund is up 6.87% so far in 2002, according to Morningstar.

Yacktman places big bets on a select few companies, an investment strategy that produced a scattered record. He was Morningstar Manager of the Year in 1991. In the late 1990s, the Focus fund lagged its peers in the value universe. But this year, his fund is the best performer in the mid-cap value category.

Want to know the rationale behind loving Tyco? Read on.

1. You're only invested in 21 companies. Why such a limited approach?

Well, I guess the question is: "Why not?" Why not focus all of your money into your best ideas? That's what we try to do with the Focus fund. Over time you're better off sticking with your best option.

2. How do you determine what are the best options?

This is what I tell people most of the time. Look at our logo, which is a triangle. There are three sides to our strategy.

One: Buy inexpensive businesses. We put a value on the business. We buy it at a low price. Basically, that shows up in price-to-earnings ratios at a big discount to the S&P 500. Not everything we buy, but as an overall portfolio, it does.

Two: Look for businesses that have high returns on assets. If you deleverage the balance sheet and look at returns on assets, it gives you an idea of what you can do -- what kind of cash those assets generate. That tends to push you towards less capital-intensive businesses because a lot of times, the capital-intensive companies have to borrow money to get their return on equity up.

Donald Yacktman, Manager, Yacktman Focus

Assets: $15 million

One-Year Return: 14.61%

Five-Year Average Annualized Return: 1.28%

Expense Ratio: 1.25%

Top Three: Tyco (TYC), Lancaster Colony (LANC), Liberty Media (L)

Information: www.yacktman.com or 800-356-6356

Sources: Morningstar, Parnassus

Three: Look at what kind of a job management does at capital allocation. We like managers who will grow the shareholders' wealth. What one has to do is not to look at what they say they're going to do, but what they actually do and how well it has worked.

3. How do you gauge managers?

CEOs have five options with the cash the business generates. One, they can grow the existing really good businesses they own. Two, they can make synergistic acquisitions. Three, buy back shares.

The other two aren't such good uses of cash. Four is paying down debt -- although if you're overleveraged for some reason, you may have to use cash flow or sell off assets to pay off debt. And five, which we think is a poor use of cash, is paying a dividend, although most companies do it.

4. What have you bought?

The fund is allowed to put up to 50% of its assets in businesses where we own over 5%. And right now, four fall into that category, making up 30% of our assets. Three of them are stocks and one of them is a bond.

Tyco is the largest holding.

5. Come again? Would you mind following up on that one?

(Laughs.) And you say, "How do you get here with what I just said?"

Well, Tyco has real businesses. And it got down to a price that finally tempted us. Our average cost on Tyco is in the single digits. We did not pay up for Tyco.

6. You're not spooked by the management issues at that company?

By the time we bought it, [former CEO Dennis] Kozlowski had already been out or was virtually out. We only bought this over the last couple of months.

So they were going to change managers -- that's number one. And number two -- they were going to sell off CIT(CIT), which gave them cash to pay off their debt. And like I said, they have legitimate businesses there. There are things like ADT, AMP, U.S. Surgical and those are all good businesses. These are not fly-by-night operations here. This is not Enron.

7. How about another one?

The second one is a company we've owned for a couple years now -- Lancaster Colony(LANC).

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And Lancaster is a fabulous business -- an underappreciated good business. The company has had 39 years of rising dividends. About 75% specialty foods, with the rest being candles and glassware. The family owns 25% of the company. Virtually no debt. They buy back shares and make synergistic acquisitions.

The third one is Liberty Media, which is also new. Basically that's us saying we believe John Malone is a very good operator. You're buying a mutual fund of cable-production businesses and we think he knows that business. And at these prices, our cost is roughly where it's selling now -- in the lower $8s. That's a lot lower than it was at $30. It's a different equation.

8. What about the bond?

Qwest. You're down to about four basic regional telephone companies now. You've got SBC Communications, Verizon, BellSouth and Qwest. And here's a company that's overleveraged; they're in the process of selling down assets and the debt should be very good.

And at these prices, why take the risk on the common when you can get an enormous return by owning these bonds, which are 50 cents on the dollar? Here you get a 20% return, so for all practical purposes, it is a stock. But it's called a bond.

9. You've got about one-third of your assets in cash and two-thirds in stock. Have you been putting more cash to work over the last few months as the market came down?

For a while, we weren't spending because we couldn't find any good bargains. Lately, we've used a lot of cash on Tyco, Liberty Media and Qwest. All of a sudden -- boom -- you had a tremendous change. But our cash position is still pretty high. But it's partly because we just got a lot of cash in. Sometimes we get these market timers that come in and out [of the fund].

The fund today is actually a little abnormal, but we're still over 30% in cash. Cash is not something that we pay attention to. It becomes a residual. But if there are bargains out there, we'll buy them and try to be concentrated as much as we can. Like today, for instance, we had almost $5 million in cash in that fund and it's only got $29 million in it. If you take that cash out, it changes things.

There's usually enough cash to handle the redemptions. If we had to sell something, we'll sell it.

10. Stocks have fallen across the board, which may make lots of companies appear attractive to a value investor like you. What keeps you out of the big losers?

I think if one goes back, one can always find a way to be humbled in this business. You never buy at the bottom. You never sell at the top. So you're always wrong. It's just a matter of degrees. The important thing is to avoid the disasters.

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