ap1234

Does anyone know what percentage Valeant is of the PSH NAV (either at Dec. 31st or more recently)?

Dazel, I attended a presentation with Prem and Paul. The question was asked about the composition of their hedges and whether they have been beneficiaries of their bearish views on China. It sounds like their short book consists of individual short positions on some natural resource stocks (BHP, Rio, etc.) as well as highly valued "tech" stocks (Tesla, etc.). They said their gains from the natural resource shorts were relatively small (it didn't sound overly material). The reason they didn't make a larger bet on the China short was that they couldn't find a cheap way to get exposure to the idea. In contrast, they built a large deflation position because they felt the cost was relatively modest in relation to potential payoff if their thesis played out. As an aside, I got the impression that the deflation swaps have likely reversed some losses from last quarter and they are quite optimistic about the value of these positions over the next few years. In terms of the Russell hedges, they are in place not for a 5-10% market correction but because they are worried about a 30-40% correction. They are unlikely to reduce the hedges until we see a meaningful drop in equity prices. They use the Russell hedge for two primary reasons: 1. Protect their balance sheet. If you aren't careful you will need money at the wrong time. 2. They worry about a market correction at the same time the insurance cycle hardens and they want to have the capital to double their premiums when their competitors are shrinking. Hard markets don't last long and you need to be in a position to write more business when capital is leaving the industry. Full disclosure: Long Fairfax. Ap1234

Dazel, As always, thank you for your contributions to the board! I always enjoy our posts. Similar to you, I am long FFH. I like the fact that the company acts as a unique diversifier/uncorrelated bet within my portfolio. Today’s valuation is not particularly expensive and there is a lot of embedded optionality given their defensive positioning. That said, you made a few interesting comments about Fairfax making a killing on their bond portfolio/equity hedges right now and suggested we could potentially see a 10% up day in the stock at some point. Can you provide some more color on why you think Fairfax is currently making a killing in this environment? Based upon their disclosed positions, I don’t see Fairfax’s BV growing meaningfully since Q2. I’d be interested to know whether I am missing anything? My thoughts are below: 1. Equities: Prem has said in the past that during a market downturn, Fairfax’s equity portfolio will hold up better than the market (i.e. they will make a profit on their equity hedges). Based upon their disclosed equity holdings (US holdings in 13F + Bank of Ireland + Greek equities), it doesn’t appear that Fairfax is outperforming the market on the way down (i.e. their disclosed equity positions have dropped more than the Russell 2000 in Q3). Without knowing the exact nature of the individual equity hedges, it's hard to know how it is has performed over the past few months. 2. China: Fairfax has been publicly warning about the risks in China for many years. They have discussed at length the property bubble, the super cycle in commodities, etc. However, their equity hedges aren’t directly correlated to their views on China. Based upon previous conversations with management (unless anything has changed over the past few months), my understanding is that they didn’t use equity hedges to directly profit from a Chinese slowdown. Instead, their view was that if China slows down there will be contagion around the world and the most expensive stock markets (ex. Russell 2000) will be impacted. They have some smaller individual equity hedges that are more direct bets on a China slowdown but these are reasonably small in relation to their overall hedges and the size of their investment portfolio. 3. Fixed income: The majority of their bond portfolio is in US muni bonds. Less than 20% is in US Treasuries. Based upon QTD moves in US Treasuries + the performance of the muni bond index (as a rough proxy), I don’t see a significant gain. They also have some corporate bonds as well as acquired fixed income portfolio from Brit but it still doesn’t make a huge dent based upon my back of the envelope math (i.e. not significant in relation to the company's BV). While I would love to wake up and see Fairfax up 10% in a day, nothing as of yet leads me to believe it will happen. Of course if the market collapses from here (a very real possibility) and Fairfax covers the hedges and puts their cash to work, the company’s BV/share will grow materially. Some investors may begin to pay up for this optionality in advance but QTD returns on their investment portfolio don’t suggest to me that they have grown BV materially. If I am missing anything, I'd love to hear your analysis.

No_free_lunch, If you get a chance, it’s worth reading the earlier posts on this thread as there is a discussion of the company’s history as well as the methodology they use to report their NAV. You can’t analyze Onex based upon their financials used for accounting purposes (i.e. income statement, balance sheet, etc.). Metrics like P/BV are meaningless. That said, on a quarterly basis, Onex provides disclosure of their invested capital along with a breakdown of their net asset value (NAV). See the link below (How We are Invested Schedule) for more info: http://www.onex.com/How_We_Are_Invested.aspx Onex’s reported NAV is not a perfect science but it’s a reasonable proxy for what they think their investments are worth. Don’t forget that Onex uses the same NAV for outside shareholders and their LPs (i.e. they don’t have an incentive to game the system). In a rising P/E market, Onex’s NAV is likely understated and in a declining market it is likely overstated. Today, it is relatively easy to value Onex given that approx. 50% of their NAV is sitting in cash (they have made an investment in both Onex Partners and ONCAP since Sept 30th). The reported NAV is $52.77/share USD or $59.50/share CAD. The stock price is $62 or 1x NAV. What is not included in the reported NAV? This is not an inclusive list but a good starting point: 1. Value of the asset mgmt. business: If you think they will generate more fees than their overhead (salaries, bonuses, etc.), then you get the asset mgmt. business for free at today’s price. 2. Future carried interest: Onex’s NAV includes the current carried interest based upon the fair value marks they apply to their P/E portfolio. As they deploy their cash into new ideas, it will likely generate future carried interest which you aren’t paying for at today’s price. 3. Future growth in NAV/share: Onex has historically grown NAV/share at healthy rates (see discussion above). If the P/NAV multiple stays at 1x forever, your holding period return will approximate the NAV/share growth (their dividend is very modest). 4. USD appreciation: If you think the USD will continue to appreciate relative to CAD, then NAV/share will grow. If you think the opposite, then NAV/share will decline. 5. Share buybacks: Onex is sitting on a lot of cash and has been repurchasing shares in the open market. In addition to putting some cash to work at attractive rates, the fact that management is buying back stock at or above 1x NAV highlights what management thinks about the value of the business (insiders are the largest shareholder group after all). As I noted in my previous post, I think the returns of the past 5 years are unlikely to be repeated over the next 2 years. The company has monetized many of their investments (which was the right thing to do) but it also means they are sitting on lots of cash earning nothing. Even if they find stuff to do with the cash (which is difficult), it will take some time for their new investments to increase in value (i.e. increase the NAV/share). Also, attractive P/E deals are still hard to come by today (it’s still more of a sellers market than a buyers market). If you have a 5+ year horizon, I think it is an attractive investment idea at today's price. If you have a 12 month horizon, I would think there are better investment opportunities. If you are interested in analyzing Onex further, I would highly recommend watching their last Investor Day which provides a good overview of their business.

I would be VERY surprised if Berkowitz exited his Fannie/Freddie prefs in Q3. That wouldn't make any sense given what he has said publicly since that time not to mention the current Sweeney court case. Merkhet and I attended the Graham & Dodd breakfast in late October (after Q3 filings). Berkowitz was one of the panelists and spoke very candidly (and with a lot of conviction) about Fannie/Freddie. In short, he reiterated his stance: either Judge Lambert is dead wrong or the law is unconstitutional. He went on to say that what the government did breaks securities law, it breaks corporate law and it breaks the fifth amendment of the constitution. Similar with Ackman, he believes there is no substitute for Fannie/Freddie and as such a compromise with shareholders is likely to be reached (whether it is in or out of the court system). As an aside, I remember a few months ago when Eddie made the loan to Sears backed by some of the company's real estate. There was lots of discussion on the board about whether Bruce was going to sell his stake as a result. Fairholme ended up participating in the real estate loan and added to its position in SHLD afterwards. That said, I think it's worth noting...IF the reason you are invested in Fannie is solely because Berkowitz is investing, then I think it makes more sense to invest directly in the Fairholme fund. You should ask yourself this question: if Berkowitz exited Fannie/Freddie tomorrow, would I still be comfortable holdings shares? There is absolutely nothing wrong with following Berkowitz. He is a great investor. But if you are going to make your decisions solely based upon his actions, it will be very dangerous going forward as Bruce won't be disclosing his positions in Fannie/Freddie. Instead, if you invest in his fund, you only pay a 1% fee and get to participate in his buys/sells in real time. I am not a Fairholme unit holder. As such, I accept the risk that Bruce may change his mind about any of his holdings at any given time. For those that wouldn't be comfortable if Bruce sold tomorrow, there is nothing wrong with that but they should probably invest directly in his fund and not try and coattail his individual holdings with imperfect information.

Is anybody going to be in LA the evening before the AGM (Tuesday, Sept. 9th)? If you want to grab dinner, let me know. I'm from out of town and would be happy to meet up with other people the night before.

What are the details (day/location) of the Pabrai AGM? I would be interested if it was close to the Daily Journal AGM. Is it open to the public?

Does anyone have thoughts on the Delaney, Carney and Himes reform legislation? This seems to be the best proposal to date (better than the Johnson-Crapo bill, etc.). I know nothing is likely to be resolved before mid-term elections but this proposal seems to be a potential long-term solution to housing reform. http://delaney.house.gov/news/press-releases/delaney-carney-and-himes-introduce-housing-finance-reform-legislation The Delaney bill attempts to preserve the 30 year fixed-rate, prepayable mortgage as well as keep home ownership affordable. These were both the arguments for why Fannie/Freddie can’t be replaced (i.e. previous private market solutions would be disruptive to the housing recovery by increasing the cost of home ownership). I would love to hear anyone’s thoughts on what the Delaney bill and what this could mean for Fannie shareholders (i.e. is Fannie common worthless if the Delaney bill is passed)?

I have been a shareholder for the past 5 years. The company actually just held their Investor Day this week. It is worth looking at the slides/reading the transcript to get a better understanding of what makes Onex different from other P/E firms. In previous years they focused on discussing the companies they were investing in. This year’s focus was on the franchise value of Onex Corp. and why it is an attractive business model. Even if you aren't interested in investing in Onex, I would still recommend checking out the presentation. The valuation of Onex no longer as attractive as it once was (it went from a large discount to NAV to a 20% premium to NAV) and the trajectory of NAV/share growth over the next few years is likely to be slower than it has been for the past 5 years (the company is sitting on a pile of cash and many of the large holdings have already been sold/monetized). That said, I continue to hold my position as my view is the company can compound capital at attractive rates over the next 5-10 years (even if the next 2 years have the potential for lower returns).

A couple of potential headwinds to be cognizant of: 1. Short-term: Equity markets have been robust and P/E firms have been very active monetizing their existing assets (i.e. P/E firms are net sellers of businesses). As the CEO of Apollo commented a while back, "We're selling everything that is not nailed down." When you monetize a lot of your assets in a short period of time you generate a lot of carried interest which inflates your current profitability and leads to above-average distributions. The question to figure out is what is a normalized level of earnings power for these businesses (i.e. you might need to adjust for the elevated carried interest)? 2. Long-term: P/E firms are people businesses (they don't have a lot of hard assets) and rely on recruiting and retaining talent. In the early days when P/E firms were private this was less of an issue and the majority of the economics (i.e. carried interest) went to the employees. As public companies, a significant % of the economics now goes to shareholders. This probably won't be a problem for many years but you should try and figure out whether publicly traded P/E firms can retain talented employees if a large % of the carried interest goes to outside shareholders and not to the young people doing the deals. My guess is this is not as much of an issue for the Blackstones of the world because they have become 'branded' companies or household names in the marketplace. As such, they will likely be able to continue to raise lots of money even if they lost some talented young people and their returns diminish over time.

BG2008, I wasn’t investing in the early 1970s so I can’t comment on the other points. But here are my quick thoughts on your point # 2 re: Munger’s performance. 1. Everyone has a different definition of value investing. My version of value investing is focusing on avoiding permanent impairment of capital (not even at the individual stock level but on the portfolio level). I don’t spend anytime thinking about avoiding volatility but I spend a lot of time thinking about margin of safety. Your reference to Munger's 50%+ drop in ‘market’ prices is a question of high volatility not high risk. It is true that some value managers tend to perform very well in down markets (ex. Buffett or Klarman). Other value managers tend to perform poorly in down markets (ex. Chou or Pabrai). It’s not as simple as saying one type of value investor is more authentic than the other. All four of the managers above are value investors. All of them believe in having a margin of safety. But some approaches lend themselves better to low volatility than others. 2. Munger has actually specifically addressed your comment in a BBC interview in October 2009. Q: How worried are you by the declines of the share price of Berkshire Hathway? Munger: "This is the third time Warren and I have seen our holdings in Berkshire Hathway go down, top tick to bottom tick, by 50%. I think it’s in the nature of long term shareholding of the normal vicissitudes, of worldly outcomes, of markets that the long-term holder has his quoted value of his stocks go down by say 50%. In fact you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”

Thanks West!

West, that's a great idea! I recently started looking at the Potash industry for the first time. Have you come across any interesting industry reports that you found insightful?

Great analysis LakesideB! In my opinion, I think you captured the salient points of the Fairfax investment thesis. The only things I would suggest if you do more analysis are: 1) Fairfax's 10 year average accident year CR is 96%. But the past 10 years is not necessarily a good proxy for a full insurance cycle. You have the benefit from a VERY hard market following 9/11 (which may or may not be repeated over the next cycle) and then a prolonged soft market from 2006-11. It seems that a combination of a few hard market years and a long soft market would equate to a full insurance cycle but I'm not certain that is the case with the past 10 years. If I were analyzing their underwriting, I would break out their individual accident year CR's as opposed to looking at a 10 year average. In other words, I don't think they really earned 96% CR over a 'full cycle'. Then you can decide whether 96% is a better proxy for the next cycle assuming no more troubled acquisitions, Andy Barnard's leadership, a renewed focus on underwriting discipline, etc. I would pick an insurance company that you think has a better underwriting culture (ex. Markel). Compare Markel's 10 year average CR to Fairfax's 10 year average CR. You can decide whether you think Fairfax has any competitive advantages in their insurance business relative to an insuarance company with a more sustainable moat. If they don't, what is a reasonable CR they can generate over the next full cycle. 2) You suggested that Fairfax can generate 7-9% returns with a market neutral strategy. I think this is the wrong conclusion. If you're going to use Fairfax's long-term returns, you might want to look at what their asset mix has been over time and what the asset class returns were (i.e. what was the return on bonds, stocks, cash, etc.). Then go through each component and test the reasonableness of achieving those returns in the future. I don't mean predicting 1 or 2 year returns. I mean what do you think each component of Fairfax's investment portfolio (stocks and bonds) can earn over the next 5-10 years. For example, Over the past 30 years corporate bond returns have been 8% (this coincides with Fairfax's history as a public company). If you think corporate bond returns will be 8% over the next 10 years, then Fairfax's investment capabilities should generate similar returns (i.e. start with 8% then add Fairfax's alpha). If you don't, then you need to have a view on how the portfolio would look different so they can still generate 7-9% returns when the massive tailwinds of declining int. rates are gone. Even a 6.5% investment portfolio return with 25% in equities and 75% in cash/bonds may or may not be optimistic over the next 5-10 years. Everyone will have a different interpretation on what future investment returns will be but I think it's important to dissect why they achieved the returns they did in the past and what is the likelihood that similar returns will be generated in the future.

I had lunch with another investor at the end of 2008. He was a Google shareholder at the time and recommended that I read Planet Google. I finished the book on a Sunday and bought the stock on Monday morning. It's the first (and last) time I've ever done that before. Granted, it helped that stocks were selling at fire sale prices and Google was at $300. I read the book 4.5 years ago and Google's business has changed quite a bit since then. However, at the time Planet Google left quite an impression on me. I remember thinking at the time that the book clearly laid out the company's moat. That wasn't the author's intent (i.e. it wasn't an investment book) but it was clear after reading the book why Google had surpassed some of the earlier search engines and why at the time Google's competitive position seemed firmly entrenched. The other thing I remember about Planet Google was the section on potential threats to Google's business. One of the chapters talked about the threat of Facebook. At the time, I thought it was really strange to think of Facebook (a social networking site) being a direct threat to Google's core search business. The two business models seemed mutually exclusive. After reading the book, I had a much better appreciation for the long-term threat of open vs. closed networks. As a Google shareholder, I used to worry that one day Facebook would announce a search partnership with Microsoft Bing and that users would not have to leave the Facebook network as they could perform their searches while logged into their Facebook profile (i.e. effectively blocking Google products from infiltrating the network). The more time you spent inside Facebook's closed network, the less time you were touching one of Google's products (i.e. less advertising revenues for Google). Anyways, the book was written in 2008 and probably isn't that relevant today given the pace of change in the industry. But if you're interested in a good general read on the business and the company's history, it's not a bad place to start. I read In the Plex as well. The book provides some interesting insights into how search engine algorithms have evolved as well as the economics behind Google's different types of ad revenue models. That said, I agree with the earlier comments that the book was somewhat off a puff piece.