petec

SD sorry for my ignorance but what’s the capacity that’s coming back?

Good set of numbers from BlackBerry got lost in the market hubbub this week.

Quite a bit going on here under the bonnet. Dundee Securities sale is a nice monetiser and hardens up some BV. Also I see the ICC/Aurora deal has closed and Union has also sold Peru power assets to PIF for shares. Those two stakes (assuming 1.2m shares of PIF, not the 2.5m potentially payable under some circumstances) are worth $40m at market today, but presumably deserve some discount as they are held through Union. Does anyone have a sense of what else is in Union and whether there's any progress on Dundee actually being able to monetise it?

So they’ve already taken 15m of capital out, they’ll take 5 more, and then they’ll be paid 4? Am I reading that right?

Such as?

One thing I am noting from the latest filing is Sanmar common equity went from 554 (million Indian rupees) to 208,854. There is a section that gives reasoning but it is a 376 fold increase in a quarter and holds up the shareholder equity and book value per share in the bottom line for the year and the quarter. How does such a dramatic increase work out? https://s1.q4cdn.com/293822657/files/doc_financials/quarterly_reports/2018/2018-Q3-Interim-Report-(FIH)-(Final).pdf "Sanmar Common Shares At September 30, 2018 the company estimated the fair value of its investment in Sanmar common shares using a discounted cash flow analysis based on multi-year free cash flow projections with assumed after-tax discount rates ranging from 13.4% to 16.6% and long term growth rates ranging from 3.0% to 4.0% (December 31, 2017 - 15.2% to 19.5% and 2.0% to 3.6%, respectively). Free cash flow projections were based on EBITDA estimates derived from financial information for Sanmar's four business units (with additional financial information and analysis completed for Chemplast's underlying business units involved in new capital projects) prepared in the third quarter of 2018 by Sanmar's management. Discount rates were based on the company's assessment of risk premiums to the appropriate risk-free rate of the economic environment in which Sanmar operates. In the third quarter of 2018 Fairfax India recorded unrealized gains of $225,013 on its investment in Sanmar common shares primarily as a result of: (i) positive operational developments at Sanmar Egypt (successful completion of its increased capacities in Egypt) and Chemplast (will benefit from the completion of new capital projects); (ii) continued strong demand for PVC and related products in India, Europe, the Middle East and North Africa; and (iii) the decrease in the after-tax discount rates (principally related to the decreased risk at Sanmar Egypt as a result of the completion of its capital expenditure project to increase capacity). At September 30, 2018 the company's internal valuation model indicated that the fair value of the company's investment in Sanmar common shares was $208,854 (December 31, 2017 - $556). The changes in fair value of the company's investment in Sanmar common shares for the third quarters and first nine months of 2018 and 2017 are presented in the tables disclosed earlier in note 5." Didn’t Sanmar repay a big loan to FFH? My recollection was the original equity investment was valued almost at 0 and most of the financing was the loan, so when the company repaid the loan the equity value will have risen dramatically.

Eurobank and Grivalia have just announced that they will merge. Fairfax will own 33% of the newco. The merger creates a much better capitalised banking group - in effect it is an equity issue by Eurobank in return for a cheap asset. It's accretive (for what that's worth) to earnings and capital ratios but dilutive to Eurobank's bvps. The merger also gives Grivalia's excellent management team operating control over the big Eurobank real estate portfolio. Eurobank has also announced plans to speed up bad loan reductions by securitising them and spinning the securities out to shareholders. This cleans the bank's balance sheet but allows shareholders to participate in any upside. Fairfax controls Grivalia and has seats on both boards so this isn't happening without their approval. Links: https://www.eurobank.gr/-/media/eurobank/omilos/grafeio-tupou/etairikes-anakoinoseis/2018/etairiki-anakoinosi-26-11-18/etairiki-anakoinosi-26-11-18-eng.pdf?la=en https://www.eurobank.gr/-/media/eurobank/omilos/grafeio-tupou/etairikes-anakoinoseis/2018/etairiki-anakoinosi-26-11-18/investor-presentation.pdf?la=en

I don't mean to restart this debate (useful though it was) but I forgot to mention something that people might find interesting. I don't know if there are such indentures in the BB debt issue. But there are at least two useful protections in the SSW one. First, SSW can't increase the dividend without compensating FFH for the value thus detracted from its debentures. And second, the price of getting FFH to agree to early exercise of the warrants (which is what took the commitment to $1bn) was that Fairfax got the option to ask for the debentures to be repaid within a year. As such they have been reclassified as ST debt (although FFH has waived its option for this year, so they're back in LT for now). In effect this option means SSW can't do anything that imperils its liquidity or FFH would have them over a barrel. It's not quite a capital allocation veto, but it's useful nonetheless. Yes, the main risks currently faced by SSW are not internal to SSW, but rather external (fuel costs, counter-party risk on contracts, the demand for shipping as manifested through GDP/trade growth, environmental regulations, risk/security of transit in international waters, state sponsored competitors, etc). SSW currently doesn't have scads of cash to burn, so the internal decisions have limited scope to cause FFH grief. On the other hand, once FCF starts to really roll in, that's when the cash allocation decisions become really important -- repay debt, buy a bunch of new ships, buy a subsidiary, buy back shares, etc. Hopefully FFH will have an exit strategy to repatriate its capital in a profitable way as the FCF rolls in! SJ Agreed. I happen to think all those risks are low given some are passthrough (fuel costs and environmental regulation costs) and given where we are in the cycle (we have had 10 years of low rates, supply overhang, slower-than-expected growth, and stress testing counterparty risks; now the order book is tiny and capital is getting more expensive). The main risk I see is a trade recession which I find very hard to forecast, but I'd worry a lot more if the contracts weren't there or there was a supply overhang. NB the cash has started to really roll in ($130m FCF in q3). My guess is FFH gets those debentures repaid when they mature and exits its equity at a higher price at some point - or, if Sokol is building a diversified asset-based company as seems to be his strategy, maybe FFH are long term partners in that. Will be interesting to see how it plays out. FWIW one option that seems unlikely is buying new ships - from call commentary sounds like consolidating the industry and adding different asset types is more likely than newbuild at the moment. Worth pointing out if they exercised all the warrants today they'd book a gain of over $250m.

It certainly isn't all roses and sunshine with FFH. I don't think anyone is arguing that it is. I love HD as a business - but I imagine it was trading at a pretty low multiple in 2009, when FFH was flying high because of the success of its CDS bet. FFH has then had a torrid time with the hedges - a mistake they have said they won't repeat - while HD has benefited from some epic money printing and cheap mortgage availability. HD may well be a better genuinely long term investment than FFH - I have no dog in that fight - but when the 9 year period you've picked happens to coincide with one prolonged upcycle, then I don't think you can argue it's a long time. Any definition of "a long time" needs at minimum to include one complete business cycle IMHO. We are a long way from completing the business cycle that started at the bottom in 2009.

I don't mean to restart this debate (useful though it was) but I forgot to mention something that people might find interesting. I don't know if there are such indentures in the BB debt issue. But there are at least two useful protections in the SSW one. First, SSW can't increase the dividend without compensating FFH for the value thus detracted from its debentures. And second, the price of getting FFH to agree to early exercise of the warrants (which is what took the commitment to $1bn) was that Fairfax got the option to ask for the debentures to be repaid within a year. As such they have been reclassified as ST debt (although FFH has waived its option for this year, so they're back in LT for now). In effect this option means SSW can't do anything that imperils its liquidity or FFH would have them over a barrel. It's not quite a capital allocation veto, but it's useful nonetheless.

Noted & fair. I tend to view these big positions as very long term. What FFH is trying to do here is build value by appointing excellent management, so I worry less about liquidity but I acknowledge the risks of this can be higher under some circumstances. So long as those risks aren't correlated, though, I don't mind large, carefully-structured (debt/equity/warrant) investments. I prefer SSW to BBRY, but that's because I think FFH got a genuinely good deal on SSW while what they've been doing with BBRY is trying to save an old, failed investment. The psychology of that bothers me more than the pure risk/reward/size dynamic.

Agreed. FWIW I wasn't trying to be pedantic - I've only heard the term cash burn in the context of a company that is operating cash lossmaking and only has a finite amount of cash to keep itself alive. I've not heard it used in reference to investment activities except in hindsight when it is known an investment was a bad one. I agree that FFH is limited in its flexibility, but I would draw the outcomes differently: 1) BBRY operating performance deteriorates and FFH is forced to roll the loan to protect its equity investment because BBRY needs the cash and no-one else will lend. This is the situation in which you are 100% correct about the position sizing. I currently think it is a low probability but I may be wrong. 2) BBRY is still net cash and is generating FCF but the convert is out of the money. In this case I see no reason why having Prem on the board reduces the likelihood of the loan being repaid. FFH is under no obligation to extend and the loan can be paid with cash - or, another lender could be found. The only reason Prem would extend is to maintain the conversion right if he thinks the shares are undervalued, and if he does he might push for better terms (higher coupon, lower strike). 3) the convert is in the money when the loan expires (2020). Then Prem has to convert, and the position size is too big, and it's tricky to sell while Prem is on the board - but we have made good money from today's starting point. In this case PC readily agrees with SJ that the position size is too big, until the company gets sold for $40/share and then with the benefit of hindsight we all agree Prem is a misunderstood genius. OK, maybe not that last bit - although having listened to JC discussing BBRY I think his endgame is a sale. Useful discussion although I'm busy for the rest of the day so can't contribute much more.

I hadn't seen that presser when I drafted my post. It's a bit embarrassing to be musing about the possibility of burning cash when the truth was that the cash had already been burned a few hours earlier. :-[ SJ No, it's been spent. We will find out whether it has been burned over the ensuing few years. I have no opinion on this currently although I look forward to JC's explanations. Incidentally, we haven't discussed one other risk with BBRY, which is that FFH chooses to convert and doesn't sell. Then I would worry about the position size.

I agree entirely about the need to probability-weight. But I suspect I do weight the probabilities for these two stocks differently than you do. That's partly due to current business momentum, which can change but is currently improving in both businesses. In Seaspan's case it is partly to do with the existing contract durations and the global order book, which is basically zero in the ship classes where they have uncontracted time - together these make high FCF for the next few years not probable, but highly probable. In both cases it's partly to do with management. FFH skew the probabilities strongly in their favour, in my view, by partnering/picking good CEOs. In Seaspan's case, for example, I find it notable that they do not intend to order new ships simply to maintain the fleet as ships age. They will only do it if they can get decent returns. In other words they'd rather run the business off than invest at poor returns. I suspect, although I cannot prove, that the same is true of John Chen at BBRY. That dramatically improves the probability of the debt being money good. To be clear I'm not advocating an equity position in either, although I am long SSW. I'm simply saying I think the debt portion of both investments is highly likely to be safe and one has to take that into account when debating position size. A $1bn position is 2.5% of the portfolio and 5.5% of equity (I am assuming one should include minorities in this calculation, but obviously that does depend on where the positions are held). I think this overstates equity exposure for reasons given above. As a resut I am comfortable with these position sizes (but they are close to the limit, for me). What would you consider to be acceptable position limits? Finally you may well be right about the p/bv. I don't care. I'm not in this hoping it will rerate, although it is a nice option. I'm in it because I don't have to pay a premium to book value for an asset that I think will compound nicely over the long term. If their investing style holds back the p/bv multiple so I can keep adding as I earn, great.

Ha ha - yes great timing. This has been coming for a while. I've seen a lot of speculation. If the target company has no debt, BBRY will still have net cash after this by my maths.

Hi all @Gary: not sure yet. If it's because FFH have stepped up options issuance in a structural way then I'm disappointed. If it's related to the Brit deal, which is what I suspect, then it's a one off. What concerns me more is why they don't talk about diluted book value per share on the calls. If there isn't a good reason for that then it's very disingenuous. I need to do more work here. @SJ: Obviously you're right that being up the cap structure doesn't necessarily mean being safe. And where I have come to think you are 100% correct is on the sizing of the hedge. But I do wonder if you're looking at the same two stocks I am in Blackberry and Seaspan. Blackberry is heavily net cash and has turned FCF positive. The only way it's not going to be able to repay that loan, which matures in less than 2 years, is if it does a bad acquisition, which is possible, but FFH hand-picked the CEO and have seats on the board so they have at least some influence. Seaspan has a bit over $4bn of net debt (not including prefs) but it's fairly well laddered and from q3 of this year SSW is generating $500m a year of FCF, which was predictable when FFH made the first loan. I'm actually astonished that Seaspan had to give away so much equity to get the money they did from FFH - SSW had zero capex from May out and were quite clear about that. They will make huge inroads into their debts over the next few years. I regard the odds of Fairfax getting trapped into rolling loans to both companies as being functionally pretty close to zero. If they roll it's because they want to. @ Viking: I'm certainly not defending the Blackberry investment - the equity portion of it has been a complete dog and the debt part didn't come at a great price. I just don't view it as a $1bn equity position like SJ does. As for Apple, well done you if you made that call. I didn't, and I feel pretty silly about that, but then I did think Microsoft was an absolutely easy win at $25 in 2010 when everybody was telling me it was going to be outcompeted on all fronts and Ballmer was a ding dong (I like that phrase). My point is simply that what's obvious to one person isn't obvious to another, and that doesn't necessarily make the other person a dummy except in the cold glare of hindsight, which can go both ways. There are other investments that have done very well that never seem to come up in these conversations, like Quess, not to mention the businesses they've built and surfaced value from. Ex-hedges, book value would have done OK these last years, and they've said they won't hedge like that again. That's important. I agree with your characterisation of their equity investment style when it comes to minority/disposable stakes, but not for operating companies nor, arguably, control stakes like Grivalia. This makes sense to me: take advantage of silly market prices for things you don't want to own forever but buy quality at a reasonable price for things you do. And I agree with you: if you don't like it, there's no point being disappointed, just don't buy it. I do like it. I like the operating businesses, the brain trust, the record of building businesses internally (which I do think is under-recognised), and the value mindset, which won't always work, but when it works it works well. And I like the current price, which doesn't seem to me to offer much risk of permanent capital loss. Ten years ago the prevailing thesis was that FFH were great investors but terrible underwriters. Funny how things change. I expect that over the next five or ten years they will get the opportunity to go long at great prices and one of those impressions will change again - but only one. That might provide a great exit valuation. As an aside I invest for two things: returns and sleep. I could have made more money in other things over the last decade, but I wouldn't have slept as well. Others don't feel the same way. That's the nature of the game. I'm not trying to persuade you into FFH. Don't buy it if you won't sleep. There's plenty of other stuff out there.

Well, Prem’s no longer the one doing the talking so you won’t have to listen to him so much any more. On Seaspan specifically he does talk a lot about Sokol (who was once so respected by Buffett, don’t forget, that many considered him to be the likely next CEO of Berkshire) because Seaspan is primarily a capital allocation story. I’ve written about how much cash it is generating on the Seaspan thread, if you’re interested. Prem has also talked about the value they see there. He’s not going to talk about the moat because it hasn’t got one, but then nor really did Midamerican. At heart FFH aren’t moat investors when it comes to equities (although I would argue they generally are when it comes to operating businesses). If that puts you off, I’d advise buying Markel or Berkshire instead. More broadly a lot of Fairfax’s investments are fundamentally jockey businesses. There are some incredibly impressive people running even some of the smaller subsidiaries. I like that, and for all Prem’s mistakes I think he’s done a good job of assembling a brain trust and creating a culture in which they stay. As for position sizing, as I’ve said before it’s important to distinguish between what’s convert and what’s equity. From an equity downside perspective Blackberry is under half a billion. That may still be too high for some tastes, but it’s not a billion. Same goes for Seaspan, even after the coming warrant exercise. I don’t see a risk in an oversized position in value cyclicals because they’ve been so clear that they still see macro threats. They didn’t go all in in the February sell off and I doubt they’re doing it now. I hope I’m right. As for catalysts, I haven’t a clue. But they own a lot of cheap stuff (I’m trying to find a platform that will let me buy Grivalia) and I didn’t foresee the value reveal/creation at Quess, ICICIL, First Capital, etc. One of the things I like about Fairfax is the value creation is so lumpy and untrusted by the market that it never seems to get priced in and you can buy it for free. But I accept you have to trust that it’s here. You can’t model it.

Can we separate these two threads and put them in the investment ideas section?

Yes, but no guarantee that Parliament will back it. (I suspect they will bottle it at the last minute and back it, but there's no guarantee.)

I couldn't find any news. Q3 release is in two days. It's possible that information has leaked about the results and its not good. Or maybe someone just wants out before the results are announced. It seems a little desperate to crash the price to do so, but we will know in two days. Agreed.

Was there any news yesterday? 10% down on not much volume.

Am I reading this right? Note 11 on p20 gives basic shares outstanding and shows that they have bought far more shares for the stock awards scheme than they issued, which makes sense if they think the shares are undervalued. They issued 76k or about $35m worth over 9 months. Note 12 on p21 shows 938m dilutive share awards. This is a cumulative number. The fact they’re dilutive suggests they’re in the money but without notes it’s very hard to tell when they vest and become basic, or whether the increase y/y is due to new issuance or some other change (unlikely to be due to share price increase, sadly). One table suggests the share repo is moving well ahead of issuance, the other doesn’t. At the very least they need to discuss why they don’t disclose bvpds rather than bvpbs.

Possibly a very dumb question but if you have a number of discrete assets (I’m thinking Seaspan here but could equally apply to a REIT or similar), what’s generally the most cost-efficient form of debt? All else equal, is it: A) secured asset-level debt, or B) unsecured corp-level debt? Obviously secured is generally cheaper than unsecured but in this case, you’re only secured against one asset whereas unsecured gives you rights over the cash flows from many. Also, assuming the corp-level financing is a bond, you get liquidity. Anyone know?

That’s great news - visibility on an asset coming back to life. Pity the Aurora share price has round-tripped since it bought ICC. Was looking like a nice gain!

Yes but it’s a hard asset company at the end of a capex binge. The story from here is one of delevering by intelligently deploying the wave of free cash coming their way. Even if they just delever the equity should benefit by the amount of the FCF each year (holding ev/ebitda constant). If Sokol can do something smart with the cash flows then it’s better than that. We will learn a lot on the call today as they have just done their first acquisition.