petec

I should have been clearer. I recently bought this as a 6-18 month holding. I like it. But: 1) While it looks very good on P/FCF it only looks good on P/NAV, in my view. 2) I think using a 5% discount rate to calculate NAVs is crazy. To my knowledge this is only done for precious metal stocks and I think it is wrong. But I have to accept it is how the market works. 3) Trading at a premium to a NAV calculated using a 5% discount rate is even crazier - but it is still how the market works. 4) I have not modelled it but FWIW consensus has it on 15% FCF not 20-30%. I'm well aware of the tendency to extend mine life. It's one of the major (and few) structural attractions of the sector in my view. I don't follow these stocks much but I also have the sense they are very cheap vs history. Mind you that may be because I wasn't investing in 1998 ;)

Helps having a desperate parent ;)

DPM looks superb on P/CF but not on P/NAV - beware P/FCF when the reserve life is short. And that's with the NAV discounted at 5% which I always think is insane!

Outstanding. Thanks Parsad. If they do another I might have to sign up!

Incidentally while it may or may not be true that Prem's daughter Christine wouldn't get a board position at any other public company, she's Director of Research at Sprucegrove which has $20bn AUM and which appears to invest in exactly the kinds of stocks that the "why don't they just buy quality and hold forever?" crowd like.

I agree. I think the FFH method works much better with things like the credit default and deflation swaps, where for a relatively limited outlay you generate an outsized return in a scenario the market thinks is improbable. That's the kind of hedge you can buy and sit with for a long time. We have bashed FFH for hedging equities and for the size of the bet, but I've often wondered whether they could have structured it as a cheap, deep out of the money index put option rather than a TRS.

True, but FWIW they don't time the market. They take macro bets. There's a difference. All of the CDS, equity hedge, and deflation bets were held for 6+ years. They took a view on what was going to happen, not so much when. They feared a depression. They weren't wrong about the timing, they were wrong about the probability of a depression in a fiat currency system.

No, I don't think so - they're tightly related. I think that to a significant degree good management makes a good business. At the risk of making this a quotefest, I'm not saying you can polish a turd - but you can put glitter on it.

One of the few Buffett pearls of wisdom that I question is his comment about how when a business with a bad reputation meets management with a good one, it's the reputation of the business that survives. I'm sceptical because as a rule I think management is absolutely key in business success. In my experience very few businesses are so good that they can do well under bad management, yet very average businesses can do well under good management. Ironically Buffett's two main businesses, insurance and investing, are excellent examples of this, and his emphasis on the people who run his businesses suggests to me that even he doesn't really believe the quote. Clearly if a business is in secular decline the best management in the world won't save it. But as a rule I tend to think smart management make all the difference in the world. Thoughts? Examples?

Good discussion here. Apologies for the long post coming... @SJ: you've been one of the most helpful commentators for me in honing my views on FFH - thanks. I've come to agree that the hedges were egregiously mis-sized (although I can't really criticise as I liked them at the time). On BB your analysis regarding an exit looks right to me - I suspect that's either a permanent holding for them or it gets sold outright. It's fair to debate whether they should enter positions they can't exit easily, but they do it quite consistently so it's just something you have to be happy with if you own the shares. I think they have an impressive record of using their influence to pick managers and build businesses so, with reservations, I am happy. I don't follow BBRY closely but I like what I see happening there at the moment. As for the multivoters and kids on the board: I like family firms. Clearly they come with generational/handover risks but they can also eliminate agency issues. If you get a good family, you can do well. So far I like the Watsas. Prem doesn’t pay himself much except via dividends which benefit me too. He has built a hell of a platform, attracting and keeping great people which is hard if you're only working in your own interests. I like the emphasis on community involvement in the annual letters and I like the employee share purchase scheme which can help relatively junior employees amass lifechanging wealth. I like the fact that the kids don't work at the firm. I dislike that Ben got money to manage without very clear disclosure on his record and fee - again communication is lacking - but beyond that I do not see much evidence that this company is run for the family rather than by it. I will be watching carefully to see if the kids have inherited the same traits. Given all that I like the control block, and therefore I don't mind that the control block was maintained by increasing the number of votes. You either like the control block or you don't. If you do, frankly, how many votes they have is irrelevant. If you don't then any multivoting structure should worry you. I like the fact that the kids are on the board - frankly if they are not qualified then it's crucial that they're on the board and learning, if they are going to inherit the votes. There is no limit on the number of board seats so there's still room for good advisers/challengers and their presence does not make the board an echo chamber. The only improvement I'd suggest is that they shouldn’t have votes for 5 years but it's all rather academic given Prem's multivoting shares. More broadly, when I look at the quality of the people Prem attracts and retains I find it hard to believe they don't challenge him. As understand it the recent revamp of the investment team was partly due to discontent among the second generation, who now have more responsibility. That's not an echo chamber, that's a leadership team listening. That said, I accept something went badly wrong in the decision process re: sizing the hedges. That's a big bit of evidence in your favour, and it's important we hold them to their promise not to do it again. Finally you mention spurning large cap value in plain sight. That's true, and I think they've recognised that failure (evidence: the comments in the last letter about how much the left on the table). They made an egregious error. I doubt they will make it again, if they get a similar opportunity. (As an aside I don't care much about that particular error. Ideally I want FFH mainly to do things I can't do myself, like providing the capital to turn SSW around on good terms or making private investments in India. Their failure to buy large cap value didn't affect my returns that much, because I owned plenty of large cap value directly. What did affect my returns is that they bought too many dogs and hedged a rising market.) @RB: perhaps the just election was a face-saving excuse to remove the hedges, but I suspect the real explanation lies somewhere in the middle: the obvious failure of the hedges and the effectiveness of QE in preventing a depression was making them reassess their thinking anyway, and a tax-cutting, deregulating president was the final straw (not just an excuse). The idea that election results are somehow not investable facts, as you imply, seems odd to me. Politics dramatically impacts economics. Perhaps stock-picks shouldn’t be greatly impacted by politics but macro bets absolutely should be, and the hedges were a macro bet. I don't think the S&P would have gone to 2900 without the Trump tax cuts, although I could be wrong. Fairfax's thinking on this is entirely consistent: much of their investment in India was predicated on the idea that Modi's reforms would have a big economic impact, and they included similar factors in their analysis of Ireland and Greece and probably others. Incidentally, one risk that no-one has mentioned yet is that Modi does not win again in May. @shalab - it's imperative to compare any investment to other businesses and if anyone takes offence all it will do is impede their learning. @Dazel, I haven't got to the bottom of the share issuance but I believe it is at least partly related to the revamp of the investment team - newly senior people being given skin in the game. If so the devil is in the details: who got what, and why, and whether it is one-time or ongoing. Again better communication is in order - this should have been a key topic on the last call. @meiroy, yes, they're value investors when it comes to picking stocks but with a macro-driven derivatives overlay historically which I suspect has at least partly come from their bond thinking where they have made very successful macro bets over time. Incidentally, I am always struck by how much of the investing discussion focuses on Prem. Clearly he's highly influential. But if you read the letters and the history there are a lot of other people involved - Bradstreet, Lace, Rivett, Mitchell, Burton, etc. Some of those have stuck around a loooong time and people have regularly joined the team, which makes me think the atmosphere is reasonably collegiate - few self-respecting investors stick around if they're not being listened to and even fewer join a company that has that reputation.

Heh, I wondered how long it would take you to react SJ ;) Fair points all. My comment about communications is related to the fact that I’ve often had to go direct to the company to clarify comments made on calls etc, and often they didn’t mean what people on here thought they meant. By definition that’s bad communications. Serious question to which I don’t know the answer: why is Howard Buffett qualified to be on the BRK board?

As I recall the hedges required them to post cash collateral on a regular basis. So they weren’t required to sell these holdings particularly, but they chose to. Again I may be wrong but I remember a lot of debate on the board at that time as to whether these sales had been motivated by the cash calls and it seems they were. And here is what they said in the 2013 letter -- no mention of a 'requirement' to sell. It has migrated from 'concern' to 'required': Given our concern about financial markets and the excellent returns we achieved on our long term investments, we reluctantly decided to sell our long term holdings of Wells Fargo (a gain of 125%), Johnson & Johnson (a gain of 47%) and U.S. Bancorp (a gain of 135%). Yes - they definitely didn't admit at the time that the sale was to finance the hedges. Someone on here figured that out - can't remember who. The CPI bet is valued at virtually zero. There’s no point selling it. It’s what the equity hedges should have been all along: a low probability high return holding. House prices rising ahead of incomes is likely to be deflationary at some point, all else equal. The buildup of debt is exactly what they’ve been worrying about. They badly misjudged how long it could continue (and, perhaps, whether it would eventually lead to inflation not deflation given fiat monetary policy).

Including bonds you're right but unless rates rise bonds won't contribute much to the equity return. Incidentally that's why the float-levered equity model won't deliver the returns it did in the past. Having 3x your equity invested in bonds at a 7% return gave a great nominal return on equity. Not so much fun at 3%. Their equities are global: India, Greece, Egypt, Canada, Africa, etc. I suspect they report in USD less because of where they are invested and more because of where their insurance subs operate and are domiciled.

I agree with much of this and also own BRK (but smaller, for various reasons including the impact of geographic exposure on my overall portfolio which has a lot of US as it is). FWIW: - the short wasn't value, it was macro, and I think they were pretty clear on why they did it. - you're right they have a very mixed macro record. They got the CDS bet and much of the bond stuff right, but the equity hedge and deflation swaps wrong (both direction and especially sizing). - removing the hedge was the right thing to do and for the right reason. They said Trump would unleash animal spirits and he did. Holding the hedge through 2900 on the S&P would have been disastrous. They took the long bonds off at the same time for the same reason, a decision which has been lauded on here. They did NOT say stocks were good value - in fact they said they still had worries about valuations, and bought almost no stocks, focussing instead on converts. - I would add to your list of questions "have they learned?". It will be interesting to look back on the next decade. I'm not defending them here. The errors have been gargantuan. I'm just trying to help make the critique more accurate.

How big was their VRX position? I didn't know about that one... I don't recall specifically, and to be 100% forthright I could be thinking of Francis Chou(who seems to mirror Watsa with his portfolio quite a bit) but I'm pretty sure it was FFH, but maybe 1-2 years ago I saw VRX pop up in the filings. It wasn't anywhere near the top. Perhaps when VRX had crashed and was in the 30's or 40's. But the thing that stuck out for me was the pattern. WTF is the obsession with these heavily levered problem child companies? Like, you're bearish on everything; OK. I get it. But then what the heck are you doing allocating money to companies that look like this??? SD, BBRY, RFP, SSW.... Thats the whole portfolio betting on companies that more or less constitute the same sort of macro bet. You don't get home run turn arounds, if the broader market is, as you say it is(ie overvalued and headed towards chaos). That is what I've never been comfortable with. I am ok betting on managers who express differing views than me. I understand others have a circle of competence where I don't. But for the past decade, I can't reconcile the logic used for the FFH portfolio. It just hasn't made sense and the results have more or less been what I'd expect given how out there they are. I don't recall their investing in VRX so if you ever come across the filing again please post it. I think you're being a but (bit arguably only a bit) simplistic in your characterisation. SD was a perfect example of what you're talking about, but was very popular as a value investment and hotly debated here as I recall. BBRY wasn't levered, it just got steamrollered by the iPhone which FFH underestmated badly. SSW only became an investment as it embarked on a dramatic deleveraging under a new and proven hard-asset management team. The bottom line is that FFH are value investors. Sometimes they see value in fast growing companies (Quess) and sometimes its in great businsses at silly prices (Grivalia) but sometimes it's in levered junk at (what they think are) silly prices. By and large that third category hasn't worked for them in this cycle, partly because they chose the wrong horses and partly because value hasn't worked for a while. That doesn't mean it's all they do and beware detractors who focus solely on these losers. Equally, don't hope they will fill the portfolio with KO and WFC and JNJ and just sit there for years. I just don't think that's their style. As to whether investing in levered junk while hedging the portfolio was contradictory, I'm not so sure. This is pure speculation but it's not entirely irrational to hedge your positions in case there's a collapse but to have some levered junk in case there isn't. You don't buy Eurobank if you think there's a deflationary collapse coming, but maybe you do if you feel you're fully hedged against a deflationary collapse and want some value exposure to its not happening. Equity hedge+deflation swaps+Eurobank could be viewed as a macro barbell. I have no idea if this is what they were thinking but it's not a daft framework. What it didn't give exposure to is the epic rerating of quality over the last decade despite (or because of) record margins, but that's unlikely to recur. There is much to criticise in what FFH have done over the last decade, but it's also easy to oversimplify that criticism. My biggest criticism is actually that they are terrible communicators. Maybe that will change with Rivett doing the calls but it would be nice to get to a point where we don't spend ages debating what they meant when they said X or Y.

As I recall the hedges required them to post cash collateral on a regular basis. So they weren’t required to sell these holdings particularly, but they chose to. Again I may be wrong but I remember a lot of debate on the board at that time as to whether these sales had been motivated by the cash calls and it seems they were. And here is what they said in the 2013 letter -- no mention of a 'requirement' to sell. It has migrated from 'concern' to 'required': Given our concern about financial markets and the excellent returns we achieved on our long term investments, we reluctantly decided to sell our long term holdings of Wells Fargo (a gain of 125%), Johnson & Johnson (a gain of 47%) and U.S. Bancorp (a gain of 135%). Yes - they definitely didn't admit at the time that the sale was to finance the hedges. Someone on here figured that out - can't remember who.

Lots of partial truths here! FWIW my view is that: They didn't think the market was overvalued in 2010. Instead they made a macro call that a USA 1930's/Japan 1990s deflation was in the cards. They totally underestimated the power of printing fiat (as did I). To say they didn't sow seeds for 7 years is false. They sowed a lot of them. The problem was that many of them didn't work. For every home run (e.g. Quess) there were two disasters (e.g. BBRY, Eurobank). This is partly, but by no means only, because they are value investors and value investing has been a nightmare for a long time. In total they were more or less fully allocated to equity and also fully hedged. In other words they chose to keep their alpha but give away the market return, and then they generated negative alpha while the market took off. Oops. Judging by the wholesale changeover in the investment team and the (somewhat) contrite tone of the last letter, some of these lessons might have been learned. On the bond side they shot the lights out. The problem is that while there's a fairly deep bench on the equity investing side, on the bond side I don't think the team stretches much beyond Brian Bradstreet. Then again, I wonder if we give Bradstreet too much credit. He's been a phenomenal bond manager but I suspect some of the deflationary thinking that drove the equity hedges came from him. In summary they’ve done nothing over the last 10 years to show that they can invest well on a sustained basis. You have to decide what the next 10 will look like. Do you like what they own now? Do you think they can turn the investing side around like they did the insurance side? (Worth remembering that in 2009 they had done nothing for over a decade to show that they could underwrite well. How that's changed…) Prem has certainly given lots of people more power, partly I believe in response to growing discontent about the investing strategy. But I believe he is still very involved. If he is "semi-retired" please give evidence. Prem is not handing over to his kids - yet. The kids have joined the board. They don't work at the firm or hold executive positions. It's clear Paul Rivett is the heir to the executive throne and there's also been a wholesale shakeup of the investing team that hasn't involved employing the kids. In short there's a generational management change going on which the kids aren't part of. The worrying bit is that when Prem dies his kids will get the multivoters (and if they've bought in a lot of shares like they promise, the multivoters will have even more power than they do today). As Prem gets older understanding how the kids will use that power will be very important, but I am very glad that they are on the board because they need a decade or so of watching how the company works before they get the votes. At a deeper level FFH has an incredible bench of talent working for it and few people seem to leave. Every time they discuss an entity it seems to have someone impressive running it. It's also worth remembering that the model of using float to lever equity works very well when you do it right. Fairfax have absolutely nailed the underwriting side in a way that few predicted 10 years ago. They've also completely ballsed up the investing side in a way that few predicted 10 years ago. I personally suspect one of those changes is permanent but the other isn't. That's partly because I think they're smart enough to change, and I hope the recent reorg of the investing team is evidence of this. It's also partly because I am starting to really like some of the individual positions they own. They have the dividend because Prem is paid a pittance compared to similar executives (WR Berkeley cough cough). Plenty of people think they shouldn't pay one at all. I'd far rather have a CEO compensated primarily by dividends than by higher pay, because I am more aligned. But not growing the divi while BV wasn't growing much is a credit to Prem, not a failure. FD: I am heavily long FFH and intend to remain so. Under the bonnet they've been building an impressive machine - huge and profitable underwriting platforms with the capital to grow plus an ever-growing bench of long term control equity positions including FIH, FAH, Recipe, and the private operations. Unfortunately they've also hidden that machine well with poor investing results and too much expensive financing at the holdco. But I like what they have built and, I like the current equity positions, and it is currently reasonably cheap. My biggest fear is that for this to really fly maybe you need higher rates and I don't see much of a pathway to that at the moment, although if jobs reports keep coming like the one earlier this week we might get there. All that said, the argument that it is uninvestable has basis and is promulgated by intelligent people worth listening to. I happen to disagree but don't dismiss their arguments.

As I recall the hedges required them to post cash collateral on a regular basis. So they weren’t required to sell these holdings particularly, but they chose to. Again I may be wrong but I remember a lot of debate on the board at that time as to whether these sales had been motivated by the cash calls and it seems they were.

I’d look further than the stock price if I were you. Do you feel they’ve made good decisions? Created value? Surfaced value? Positioned themselves to create value in the future?

I don't see it that way. Even if the valuations are the same the alternatives are different. Clearly it was a mistake, for example, to sell JNJ and buy Eurobank. However several years later selling Eurobank to buy JNJ might be just as big a mistake, even if JNJ is on the same valuation as it was back then, because Eurobank's prospects might look different now. I think they're saying they should have held onto those stocks for a lot longer, not that they are necessarily the best things to own today. If they buy stocks like that again I expect them to hold for longer. That's all I infer. I may be wrong.

Do you think they have a lot of capacity to add equity exposure? I fear they’re close to their practical limit. The selloff they need is in corporate and long dated bonds. That wasn’t the point I was making. They said that they will try not to repeat the costly mistake. How else can they avoid further opportunity cost than to buy them back? They bought these equities initially and then stated something about how they had learned to hold high quality shares for the long term. Then they sold soon afterwards and now they say they have learned a lot about how much the sale has cost the shareholders. So if they don’t buy them back, what am I then to think? I understand your point. Mine is that to buy them now they’d likely have to sell something else they like. It’d be a two-part decision, not a one-part decision. Which makes it harder to make inferences and for you to decide what to think.

Do you think they have a lot of capacity to add equity exposure? I fear they’re close to their practical limit. The selloff they need is in corporate and long dated bonds.

Yesterday they announced another 15m unsecured loan into Parq from an (I think the same) industry investor. Effectively it looks like Parq operating cost is now externally funded but its debt keeps growing. That may be the best equity/pref holders like Dundee can hope for at this point.

Great record and great post.

SD sorry for my ignorance but what’s the capacity that’s coming back? Enbridge Line 3 replacement comes on-line at the end of 2019 (760,000 bpd), and the first of Alta's rail-car fleet starts arriving (120,000 bpd by mid-2020). The existing aged Line 3 does roughly 380,000 bpd. With 600,000 bpd of net new capacity becoming available, the current shut-in will end, differentials should further decline, and o/g properties currently listed for sale should start to move again. Then add to it that at current valuations it's far smarter for new money to simply buy P2P reserves at cents on the dollar, versus drill for them. Yet the oil-patch isn't talking about it? Our own view is that it's being 'squashed' until Alta's 2019 election gets going ;) https://ca.reuters.com/article/domesticNews/idCAKBN1O203A-OCADN https://www.enbridge.com/projects-and-infrastructure/projects/line-3-replacement-program-us https://www.mprnews.org/story/2018/11/19/line-3-oil-pipeline-moves-closer-to-construction-in-northern-minnesota SD Thanks. That’s all oil not gas, correct?