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The following notes were posted originally on the MKL board by "Admiral" Phillip Durrell of Motley Fool's "Inside Value" Newsletter.
Hi Everyone,

Alex Dumortier (TMFMarathonMan) and I attended (sorry I didn't meet you Richard - perhaps next year) and these are our notes which may or may not be accurate;


Q&A session with Steve Markel and Tom Gayner:

Tom Gayner: We have been doing this for presentation for 17 years and started by asking, Who are the people most likely to understand what we are trying to do? Most likely they are already Berkshire shareholders, so instead of inviting people to Richmond, we said let's go to Omaha.

There's a financial dimension to capital and that's really less than half the story. The rest is mental or fortitudinal -- the ability to stick with your decisions during difficult times. We've been doing well, but we haven't done well every day. Steve hired me to do this job when I was 29 years old. During adverse times, Steve asks smart questions and they are supportive questions. None of this would have been possible without Steve's psychological support.

Steve Markel: Back in 1986, when we went public, the IPO price was $8 per share. It's real exciting to be here 20 years later, having accomplished much of what we set out to do. We hope to continue like this pretty much forever. Not only are we doing a good job today, but we are creating a culture, a business plan and psychology that will allow us to endure.

Q: Any comments on the two private equity investments you've made: First Market Bank and AMF Bakery.

SM: A lot of the reason for doing it is to create options for ways in which to invest over long periods of time. A grocer family created this bank in concert with SunTrust. We've known the Ukrop family for years. I called up Mr. Ukrop and told him: "We like this business and if there's any way we could replace SunTrust, we'd love to be partners."

TG: The president of the company basically threw himself on the tracks for his partners. The idea of having the same owner forever was very attractive. The bigger thing about these two deals is we raised a flag and said that we are interested in investing directly in companies. We get a lot of calls from people who believe that the private equity is not perfect -- refugees, if you will. As you do deals, you are exposed to greater deal flow.

We want to prepare ourselves for when a seller's environment becomes a buyer's environment. We wanted to start learning how to do this.

Q: Describe the culture -- what has made it so successful over time?

SM: The Markel Style -- the words are contained on the inside of the annual report. We want to create an environment in which associates of Markel understand what the long-term goals are and we can then all figure out how to achieve them.

The payout for underwriters is long-term and based on five-year rolling averages. There are 30-40 people at Markel who earn more than the people who are at the top of organization chart. My pay grade is approximately number 35. We then encourage these people to put at least part of this bonus in Markel shares -- we create incentives to make that happen. We are interested in building long-term wealth for shareholders and are therefore interested in attracting people who are interested in building. We are also interested in torpedoing bureaucracy and thinking about what is slowing down or stopping us from making good decisions. That is difficult to do as we have grown, besides which we are in a highly regulated industry.

TG: We encourage you to read the annual report, because a lot of thought went into describing and capturing the organization. But words, at best, are less than perfect. In some cases, they can even be misleading or hypocritical. I saw the mission statement of a company the other day and it was wonderful -- the company was Enron. (Loud laughter.)

Q: Why do you like GE?

TG: This is not a planted question, but I do have a visual aid here. Before I joined Markel, I started out at the Davenport Company of Richmond, Va., where I worked for six years as a CPA. One of my mentors there was Ned Reynolds, who was legendary figure in Richmond. "Tom, the secret of success in the investment business is lasting the first 30 years. (Laughter.) The rest is just a replay." The other thing that Ned Reynolds used to do -- this is a Value Line sheet -- he would take it and circle everything that's good on the sheet. The average P/E ratio is 16.4, which is the lowest on the page [i.e., for its history]. The relative P/E ratio (with respect to the other companies in the Value Line universe) is 0.86. Is this a better than average company? At some points in its history, I would argue that GE was a below-average company. When I first told Steve Market that I liked GE, he almost threw up. The dividend yield and sales per share get a circle. Is the CF per share more than it was last year and was it more than capital expenditures -- is this a company that is producing FCF or consuming it? The balance sheet -- this is an AAA-rated company. If I go through this exercise, I love this tool -- it gives you a tapestry of what the company is doing over the long term. As you look at it week after week, month after month, it paints a picture.

SM: GE lost several billion dollars in the insurance business. The current management has clearly made an effort to clear out the excesses of the past.

Q: How will Markel navigate the soft insurance market?

SM: As always, we will be very disciplined. The industry is flush with cash. The top line is going to be difficult for the next couple of years. The good thing about this industry is that the bottom line doesn't have to suffer. However, we will have to suffer the arrows of people asking us: "Why aren't you growing? Why aren't you growing?" I'm absolutely confident that over the next five to 10 years, we'll have plenty of opportunity to grow the business.

Q: What will happen to commission lines and broker fees in this environment?

SM: When a broker comes to us with a demand to reduce our lines, a smart insurance executive should ask the broker how much he is willing to reduce his fee. My sense is that the brokers with the biggest policies, biggest policy size will suffer the most.

Q: You've held CarMax for a very long time. It's selling at a very high P/E ratio -- how do you reconcile this with your value orientation?

TG: I was only at Coopers & Lybrand for two months, so I'm not very good at reconciling. (Laughter) At the meeting yesterday, there was a stream of people asking Buffett for an answer, for a valuation formula. We are all sitting Graham-and-Doddsville with guideposts that are generally correct, but in specific cases, they need to be verified. CarMax was pretty pricey on day one. As luck would have it, they went through a very tough period. A stock that was trading at $20 a share on $0.50 to $0.60 of earnings fell to around $2. They were founded in Richmond, as a subsidiary of Circuit City. I was familiar with the model. I understood it and I liked it. R.H Macy was an outfitter in Nantucket that always sold at a fixed price -- no haggling. R.H. Macy set up a store for linens and such with fixed prices -- which allowed him to advertise his store and their wares at their set prices. CarMax has done the same thing in the used car market and currently they have just 65 stores in the U.S., and they have room to grow for the next 10-20 years.

The dumbest thing you can do -- if you believe in the model -- is sell it and trade around the valuation.

Q: Fairfax Financial. What do you think of the current valuation in light of the large rise in price? It's very controversial.

SM: We bought $100 million of Fairfax stock about 2 years ago at about $120 a share. Fairfax and Markel -- our histories intertwine in the '70s and '80s through a number of transactions. I've known the CEO Prem Watsa for a very long time, and I have a very high regard for his integrity and his ability as an investor and a manager. Several years ago, they stubbed their toes when buying other insurance companies and they were forced to raise some money. Prem called on number of people and we participated in a $300 million financing. Book value is around $160-$170 a share, and the stock is trading above $200 a share. A.M. Best upgraded their financial condition for the firm in the last few days or weeks. It was an opportunistic transaction to invest in a firm run by people that we trust and respect.

Q: Do you think they're out of the woods?

SM: I believed they were out of the woods two years ago. It's an unknowable question, but I think so, otherwise we wouldn't have invested.

Q: You used to talk about investment leverage targets of 4:1. Leverage is now 3:1. Did that just happen, did you want it to happen?

SM: When we first published our model, our leverage was 4 times our capital base -- at that time, Treasury bonds were trading at 7.5%, or 5% after-tax return. This would produce a 20% after-tax return without any help from underwriting profits. We have made a number of acquisitions. We are able to buy these businesses cheaply because they have been writing unprofitable business. As a result of this, our investment portfolio was larger than the premium that Markel was writing (example: say they were writing $200 million of business and had the investment portfolio to match -- as we got rid of the poorer insurance contracts we contracted the premiums written to $100 million but were still left with the larger investment portfolio). Today we have $3 of investment portfolio for every $1 of capital. If we wish to earn 20% on our capital, the underwriting needs to produce the other 5%. What's important is not so much the specific numbers, but rather the thoughtful way in which we think about these numbers. We can put more money into equity markets, which can earn a higher return or invest in other activities or share repurchases.

TG: I would just add that the leverage figure suggests a natural capital allocation between fixed income and equities. From 4:1 leverage ratio, we would expect to invest 25% of the portfolio in equities. At 3:1, the fixed-income portfolio should be closer to 66%. Higher percentages in equities will produce higher investment returns.

Q: Have you planned for the day Tom might not be here, especially with the rumors linking Tom to Berkshire Hathaway?

TG: It's not going to be my problem! We'll do the best we can and take each day as it comes.

SM: Tom's almost irreplaceable and I don't want to replace. (Tom has told me that he has not applied for the Berkshire chief investment officer position and intends to stay with Markel -- PD.)

Q: What are the risks linked to opening your office in Singapore?

SM: One of the key advantages of creating Markel International is to have an international platform. Lloyds, from which we operate the Markel 3000 platform, is licensed to do business around the world in a way that would be very difficult to replicate. The majority of the business in Singapore is likely to be linked to shipping. China is much, much farther in the future. We have sent some people there to investigate the opportunities, but it's unlikely that we will be doing anything there for quite some time. However, we're quite convinced that China will be an important part of our future.
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